Chegg - A Textbook Story of Fiction

COPPERFIELD RESEARCH
-------------------------------------------------------------------
Chegg, Inc. (CHGG) A Textbook Story of Fiction

Exposing the promotional business pivot built on financial shenanigans, the
manipulation of business metrics & pro-forma results, shareholder value
destruction, and a structurally broken business model
Fair Value - $2.00 per share, 75% downside
________________________________________________________________________1
-------------------------------------------------------------------
IMPORTANT Disclaimer Please read this Disclaimer in its entirety before

continuing to read our research opinion. You should do your own research and
due diligence before making any investment decision with respect to securities
covered herein. We strive to present information accurately and cite the sources
and analysis that help form our opinion. As of the date this opinion is posted, the
author of this report has a short position in the company covered herein and
stands to realize gains in the event that the price of the stock declines. The
author does not provide any advanced warning of future reports to others.
Following publication of this report, the author may transact in the securities of
the company, and may be long, short, or neutral at any time hereafter regardless
of our initial opinion. To the best of our ability and belief, all information
contained herein is accurate and reliable, and has been obtained from public
sources we believe to be accurate and reliable. However, such information is
presented as is, without warranty of any kind whether express or implied.
The author of this report makes no representations, express or implied, as to the
timeliness or completeness of any such information or with regard to the results
to be obtained from its use. All expressions of opinion are subject to change
without notice and the author does not undertake to update or supplement this
report or any of the information contained herein. This is not an offer to buy any
security, nor shall any security be offered or sold to any person, in any
jurisdiction in which such offer would be unlawful under the securities laws of
such jurisdiction.
________________________________________________________________________2
------------------------------------------------------------------Executive Summary
Question: What do you do when your stock price declines by 50%, your diluted share count
doubles due to egregious stock based compensation and poorly structured financing rounds
with ill-conceived ratchets, and your business model is structurally broken less than two years
after your mispriced IPO?
Answer: Why of course you announce a business model pivot on the back of nebulous nonGAAP metrics, concoct a story about a low-cost customer acquisition channel that ignores
intense competition from Amazon.com and other economic realities, alter past financial
metrics lower to overstate current period growth, create ebullient out-year financial targets
only to surreptitiously adjust the target date and growth rates when results are below plan,
reclassify your pro-forma revenue definition multiple times while including physical goodsrelated revenue in your newly classified digital revenue category (attracting SEC
correspondence in the process), further inflate revenue growth rates by recording one-time
inventory transfers as profitless revenue, boast about your strong 80% [monthly] customer
retention rate which translates into something closer to 93% annual churn when the fine
print is read, claim to grow subscribers 40% despite your own subscriber figure from the prior
years press release suggesting growth of 15%, inflate EBITDA by increasing capitalized
expenses 340% year-over-year (as a % of revenue), make 10 acquisitions that obfuscate
organic growth (and subsequently write-off multiple deals), and exclude non-recurring
items from adjusted financial results for ten consecutive quarters to magically transform deep
operating losses and cash burn into marginally positive adjusted EBITDA. And that run-on
sentence is just the beginning
Sell-side promotions and hope-based investments are often built on the foundation of a
strategic business model pivot. These stories dismiss years of disappointing operating and
financial execution as yesterdays news. Management teams and their cadre of sell-side
promoters instead encourage investors to focus on non-GAAP metrics and aspirational target
models years into the future. As a result, accounting warts, irreconcilable financial results, and
operating inconsistencies that would traditionally cause severe stock price declines, can be
marginalized and ignored at least until the story is busted.
We believe Chegg, Inc. (CHGG) is an orchestrated promote. The carefully constructed,
disingenuous bull thesis, is that CHGG is in the midst of a transition from a low margin
textbook rental business into a high growth, high margin digital educational services
company. This report extensively details why we believe CHGG has fabricated pro-forma
financial results, misrepresented its unit economics, and repeatedly provided misleading
metrics that are subsequently altered. Based on recent correspondence with the Securities and
Exchange Commission (SEC), and conspicuous changes to its financial reporting, we believe
CHGGs shenanigans discussed herein are under the microscope.
Like most promotes, CHGG and its sell-side partners use buzzwords and endorsements that
appear to legitimize the story. For example, the sell-side points out that the company was
initially funded by prominent venture capital firms such as Foundation Capital, Insight
________________________________________________________________________3
------------------------------------------------------------------Venture Partners, and Kleiner Perkins. The CEO, who was the former COO at Yahoo!, is a
veteran Silicon Valley executive who talks the talk when discussing the transition from a
capital intensive textbook rental business to a high margin digital services business. On its
most recent earnings call, the word Platform was used eleven times to describe the new
operating model, while Google, Netflix, Spotify, and Uber were audaciously listed as
compelling macro trend comps in the most recent investor deck. Bulls paint a compelling
picture of a textbook rental customer base that creates a low cost competitive advantage for
Chegg Services to acquire customers. Without appropriate diligence, managements elevator
pitch sounds enticing to retail investors and resonates with analysts.
We believe there is one problem with the compelling investment storyIT IS FICTION.
CHGGs strategic business model pivot has been marked by underperforming acquisitions,
weak execution, intense competition, and value destruction. Worse still, we believe CHGGs
management has utilized accounting gimmickry, deceptive segment reorganizations, and nonGAAP adjustments that directly violate SEC reporting standards. Management has
consistently inflated the companys non-GAAP profitability by excluding acquisition-related
compensation costs, transitional logistic charges, and/or restructuring charges for 10
consecutive quarters, while simultaneously including one-time gains on textbook
liquidations. Managements vague pro forma revenue metric is devoid of the reconciliations
required by the SECs Reg. G, while the companys aggressive and inconsistent investor
presentations appear designed to consistently overstate organic revenue growth.
CHGGs core textbook rental business is in secular decline marked by commoditization and
intense competition from Amazon, Pearson, and others. By managements own admission, the
textbook rental segment, which serves as the low-cost customer acquisition funnel for digital
services, will decline by at least 10% in 2016 and 2017. Rather than candidly address the
pervasive challenges in CHGGs core business, management has pursued a digital business
strategy through subscale, poorly performing acquisitions. Over the last six years, CHGG has
acquired 10 companies, of which four have been total write-offs, and just one has performed
to plan.
The amalgamation of these ten acquired properties represents CHGGs supposed high-growth,
high-margin digital services segment. But the facts tell a different story. We believe CHGGs
management made multiple alterations to its segment reporting to obfuscate the floundering,
low visibility, dynamics of its digital segment. Previously, management stated that its allimportant digital revenue growth would be 60% in 2016. Our analysis suggests 60% growth is
a blatant misrepresentation and digital revenue growth will be just 16% in 2016. Additionally,
based on CHGGs own disclosures, we show that customer churn in digital services is
approximately 93% annually. And while management claims its fastest growing services
business, Chegg Tutors, will pull blended corporate margins higher, our analysis shows this
segment generates a mere 30% gross margin.
We believe management has persistently altered its reporting methods to flatter digital
growth. As such, it comes as no surprise that CHGGs historical revenue reporting segments
________________________________________________________________________4
------------------------------------------------------------------are replete with discrepancies that fail to reconcile from quarter-to-quarter. In the last three
years, CHGG has reported three different revenue derivations, which we believe blatantly
overstates digital revenue growth and masks an inability to hit financial targets. The SEC
appears to share our confusion based on its correspondence with CHGG management asking
for an explanation for certain revenue segment reporting.
While managements promotional cadence has been self-enriching, shareholders have
suffered. In CHGGs 10-year history, management has raised more than $400 million,
including $180 million from the companys IPO just three years ago. Despite incessant capital
raises, CHGG has (i) never generated a profit, (ii) has an accumulated deficit of $370 million,
and (iii) will end 2016 with less than $60 million of cash in the bank before considering $35
million of acquisition earn-out obligations and expected free cash flow burn of $25 million.
No wonder sell-side analysts have been such unabashed supporters!
Like all promotes, the too-good-to-be-true story can only persist for so long before facts
trump fiction. While CHGG beat sandbagged Q3 guidance (Chegg Services revenue was
down sequentially despite only a partial quarter of its Imagine Easy acquisition in Q216), the
company guided Q4 below consensus estimates and cut 2017 expectations. We believe more
negative revenue revisions are coming. With CHGGs accounting shenanigans exposed,
competitive pressures intensifying, and 2017 guidance that appears highly unobtainable, we
believe the rubber will soon meet the road. CHGGs pivot is nearly complete and in 2017
management can no longer utilize its pro-forma revenue cookie jar to hide poor results. We
believe CHGG is trapped and managements only options are (i) attempt larger acquisitions to
plug the impending revenue hole, or (ii) confess that actual growth rates and profitability are
less than what management has led investors to believe.
We believe CHGGs intrinsic value is less than $2.00 per share, which would represent
75% downside from the current trading price.
*****************
This initial report details the following topics, representing just the tip of the shenanigans on
the CHGG iceberg:
1) CHGGs inauspicious background and value-destroying CEO
I. Disastrous pre-IPO ratchets have caused substantial shareholder dilution
Increasingly onerous ratchet conditions on multiple rounds of pre-IPO financing and
indefensible stock-based compensation have resulted in the unjust enrichment of CHGGs
management at the expense of its unaffiliated shareholders. In less than three years,
shareholders have suffered nearly 100% dilution.
II. Dan Rosensweigs dubious leadership track record
Mr. Rosensweig served as CEO or COO of three companies prior to CHGG. He destroyed
significant value at all three companies.
________________________________________________________________________5
------------------------------------------------------------------
Mr. Rosensweig was most recently CEO of Guitar Hero, one of the most popular video
game franchises in history. Under Mr. Rosensweigs stewardship, sales collapsed, a
leadership change ensued within one year, and Guitar Hero was temporarily discontinued.
2) CHGGs textbook rental business is commoditized & faces increased competition

A bullish perspective on CHGG assumes the companys textbook rental business can
serve as a low cost customer acquisition channel for its higher growth, higher margin
digital segment. This thesis appears to be false. Based on our analysis, CHGGs textbook
rental business has decelerated for three consecutive years and will decline by nearly 10%
in 2016.
Amazon has entered the textbook rental business and is aggressively targeting CHGGs
core customer base. Barnes & Noble Education, which operates over 750 college
bookstores, recently launched a price match guarantee.
Based on reviews of textbook rental comparison sites, CHGG is generally the most
expensive rental option.
3) Chegg Services stability, margins, and growth characteristics are misrepresented
I. Chegg Services faces persistently high customer churn
CHGG management claims Chegg Services renewal rate is 80%. However, management
does not openly highlight that this is a monthly renewal rate. Annual churn is
approximately 93%. Claims that Chegg Services is a recurring business are false.
II. Chegg Tutors pricing implies management misrepresented gross margins
Management claims overall gross margins will be driven substantially higher by growth In
Chegg Services. However, public disclosures do not support managements claims.
CHGGs fastest growing digital business, Chegg Tutors, appears to have gross margins of
just ~30%.
III. Management has historically squandered shareholder capital through poor acquisitions
In the last six years, CHGG has spent nearly $140 million of shareholder capital on 10
acquisitions.
4 of the 10 acquired companies/products have been shut down or discontinued, while 3
acquisitions are behind plan.
Based on our analysis, we believe just one of managements growth acquisitions is
performing to plan.
IV. Chegg Services subscriber growth is significantly overstated
While CHGG management claims subscriber growth accelerated in Q316 to over 40%,
we believe management furtively revised the metric to exclude declining eTextbook
customers and included Imagine Easy subscribers.
Based on our analysis, normalized subscriber growth decelerated to just 15% in Q3.
4) CHGG has consistently misrepresented its financial & segment reporting
1. Management has repeatedly reorganized reporting segments to artificially inflate digital
growth
Since CHGG came public three years ago, management has reported revenue under three
different segment derivations.
________________________________________________________________________6
------------------------------------------------------------------
Each revenue reclassification appears to coincide with a specific quarter in which

management would have failed to achieve its financial targets.
II. Normalized digital revenue growth is significantly below managements target
Based on company disclosures, we believe normalized digital revenue growth would be
just 16% in 2016 had management maintained consistent reporting segments.
III. Multiple revenue reclassifications have discrepancies with reported pro forma financials
In August 2015, CHGG management publicly stated pro forma revenue was $142.7
million in 2014.
In February 2016, the same 2014 historical revenue was inexplicably adjusted downwards
by 6% to $134 million.
We believe the alteration of historical pro forma results was intended to set a lower bar in
previous years to artificially enhance perceived current year growth.
IV. The SEC requested information regarding CHGGs revenue reclassifications
In December 2015, the SEC sought an explanation for why management included
CHGGs Ingram commission on physical textbook rentals in its digital segment.
CHGG management defended its segment reporting in correspondence with the SEC.
However, just two months later, management again altered its revenue classifications in
what appeared to be another brazen tactic to obfuscate organic growth.
V. Did CHGGs inventory transfer sales to Ingram artificially inflate revenue?
Under CHGGs GAAP filings, the companys Sales line item includes just-in-time sales
of print textbooks and other required materials.
Our analysis shows Sales revenue should correlate with Rental revenue. However, in
2014 and 2015, Sales revenue inexplicably re-accelerated, diverging from Rental
revenue declines.
We believe CHGG artificially inflated revenue growth by recording initial inventory
transfers to Ingram as profitless revenue.
VI. CHGG appears to be in direct violation with SEC Regulation G
Despite the SECs recent Compliance and Disclosure Interpretations on perceived nonGAAP financial reporting abuses, CHGG management appears to willfully disregard
Regulation G with its reporting of non-GAAP profitability and revenue metrics.
5) Managements egregious compensation & other conflicts of interest
I. Abusive stock compensation transfers value from investors to management
CHGG spends nearly 23% of its pro forma revenue on stock-based compensation, which
is more than 500% greater than its peer group.
Sell-side models appear to neglect over 11 million anti-dilutive shares from the
companys current share count because CHGG is unprofitable.
At market prices, a potential acquirer would need to absorb a 12% increase in the
outstanding shares based on vesting schedules and current options.
II. Managements excessive pay is not tied to performance
In 2015, CHGG failed to achieve all performance based compensation targets and the total
shareholder return was negative. In recognition of this performance, the Board of
Directors rewarded Mr. Rosensweig with $10 million of compensation.
________________________________________________________________________7
------------------------------------------------------------------
Since coming public three years ago, CHGGs stock price has declined by 45%,
underperformed the Russell 2000 by 60%, and management has repeatedly missed
performance targets. Nonetheless, Mr. Rosensweig has received nearly $24 million in
compensation.
6) Weak operating performance, cash burn, & acquisition earn-outs impair the
balanced sheet
I. Management has misrepresented recent business momentum
In Q216, CHGG management boasted that EBITDA more than doubled year-over-year.
Excluding one-time gains/losses on textbooks liquidations, EBITDA actually declined
year-over-year.
II. Significant increases in capitalized expenses may be overstating EBITDA
After exiting textbook rentals, CHGG should have minimal capital intensity.
Historically CHGG spent 2-3% of revenue on capital expenditures. However, YTD16
capitalized expenditures inexplicably jumped to 9% of revenue.
III. Management quietly pushed out its target operating model by one year
Throughout CHGGs transition from a textbook rental company to a digital business,
management has stated its target operating model of 25% revenue growth, 60% gross
margins, and 25% EBITDA margins would be achieved by 2017.
In early 2016, without explanation, management inexplicably moved its target model date
to 2018 and lowered its growth target in an investor presentation.
IV. CHGGs business model(s) perpetually destroy capital and burn cash
In its most recent earnings call, management stated CHGG generates a lot of cash.
This statement is patently false. In less than three years, CHGGs cash balance has
declined from $160 million to less than $60 million.
Despite relying on excessive stock-based compensation in lieu of cash compensation,
management expects to burn ~$25 million of free cash flow in 2016.
V. Imagine Easy earn-out payments may impair CHGGs balance sheet
In addition to paying $25 million to close its Imagine Easy acquisition, CHGG committed
to a $35 million incremental earn-out, with $27 million due in 2017.
With approximately $55 million of cash at year-end and an annual burn rate exceeding
$25 million, we believe CHGG will need to access the capital markets in 2017.
7) Rubber meets the road in 2017 & VCs and insiders are voting with their feet
I. CHGG will struggle to meet 2017 guidance
Based on our analysis Chegg Services revenue has decelerated for three years to under
30% growth. To achieve 2017 guidance, the segments growth must meaningfully
reaccelerate.
II. VCs and insiders heading for the exits before the next reset
Three of CHGGs top six pre-IPO investors have sold their entire positions for a loss.
Since August 2016, CHGGs Chief Product Officer has sold more than 80% of his
holdings.
8) CHGG is significantly overvalued
________________________________________________________________________8
------------------------------------------------------------------I. CHGG trades at a substantial premium to education-focused peers and a broader consumer
internet basket
CHGG trades at 42x EV/EBITDA compared to 5x -7x for publicly traded educationfocused peers.
Despite GAAP revenue declines, decelerating pro forma revenue growth, negative free
cash flow, and a structurally broken business model, CHGG trades at a substantial
premium to both AMZN and LNKD.
II. Generous valuation implies 75%+ downside
Applying a generous peer group valuation multiple, we believe CHGGs intrinsic value is
$1.72, or 75% lower than recent market prices.
________________________________________________________________________9
------------------------------------------------------------------1) CHGGs inauspicious background and value-destroying CEO

I. Disastrous pre-IPO ratchets have caused substantial shareholder dilution
There will be a time when this bull market ends, and when it does these ratchets will be very
painful
*** Neeraj Agrawal, General Partner at Battery Ventures1
CHGG was founded in 2005 by Aayush Phumbhra, an Iowa State graduate student, with the
objective of saving college students money by allowing them to rent rather than buy
textbooks. 2 Since its inception, CHGG has raised more than $400 million, or 67% of its
current $600 million enterprise value. 3 As we will discuss in detail later, CHGG has
recklessly destroyed over $300 million of capital through operating losses, capital
expenditures, and disappointing acquisitions.
CHGG Fundraising Analysis
$ 000s
Round
Type
Date
1
VC-1st
08/31/05
2
VC-2nd
06/30/08
3
VC-3rd
12/17/08
4
VC-4th
11/19/09
5
Debt
11/29/09
6
Corporate 08/31/10
7
VC-5th
03/31/12
8
IPO
11/13/13
Total
Source: VentureSource.
Amount
4,230
4,700
25,020
57,000
55,000
75,000
25,000
180,000
425,950
Valuation
8,080
21,300
66,190
551,550
N/A
714,600
655,970
1,217,850
How has CHGG managed to raise nearly half-a-billion dollars despite never generating a
profit, never trading above its IPO price, and attempting to redesign its operating model two
years after going public? One word ratchets. According to a Wall Street Journal article,
Valuation-Hungry Startups Should Heed Cheggs Disastrous IPO Ratchet, CHGGs
management chose to grant onerous ratchet provisions to investors to achieve the highest
possible valuation. 4 While it may be easy to argue the past is the past, we believe
management teams have hardwired DNA, and a troubling pattern exists at CHGG of selfserving actions that conflict with the interests of unaffiliated shareholders.
These ratchet provisions provide investors in specific rounds incremental shares if future
capital raises occur below a specified price (e.g., at IPO). While ratchet provisions provide
anti-dilution protection to certain investors, early investors and employees can suffer extreme
dilution.
CHGG management first offered ratchet provisions as part of the companys series D
financing round in 2009. 5 According to an early angel investor, and former CHGG board
________________________________________________________________________10
------------------------------------------------------------------member, Oren Zeev, CHGG received multiple financing offers without ratchets. Nevertheless,
CHGGs management chose the ratchet deal because it provided an initial 20% higher
valuation.6 In exchange for this paper-based wealth creation, CHGG provided Insight Venture
Partners a 2x ratchet provision. Simply, Insight would either double their money, or
CHGGs management would issue additional shares to Insight at the expense of earlier
investors and employees.7
Despite the notoriety of ratchet rounds, CHGG management raised two subsequent VC rounds
with ratchet provisions, each with conditions more onerous than the last. How aggressive was
management? Two of CHGGs fundraising rounds required the company to IPO at a price
greater than $25 in order to avoid triggering the ratchets.8 Due to clear missteps on the part of
management, CHGGs final round of pre-IPO financing, its Series F round, was raised at a
price below its previous two rounds (the dreaded down round). Although management must
have known the company faced a significant overhang due to its prior two ratchet rounds at
prices CHGG would not achieve, management again chose to raise capital with a ratchet
provision at $12.00.9
When CHGG filed its public prospectus, the IPO price range was set between $9.50 and
$11.50.10 Despite tepid institutional interest in its IPO, CHGG management priced its IPO at
$12.50, thus avoiding dilution from the additional Series F ratchet. While management was
protected, the stock price declined by 23% on its first day of trading and has never traded at
its IPO price. Due to the companys prior two capital raises with ratchet provisions, CHGG
was forced to issue 13.1 million additional shares on its IPO, which resulted in 25% dilution
to new shareholders.
Source: CHGG S-1.
Because of CHGGs costly ratchets and egregious stock compensation grants (detailed later),
pre-IPO shareholders have suffered nearly 90% dilution in less than three years.
________________________________________________________________________11
------------------------------------------------------------------CHGG Shares Outstanding Analysis

000s
Shares Shares Issued

Outstanding
or Issuable
Pre-IPO
54,257
Post-Ratchets
67,328
13,072
Post-IPO
81,728
14,400
Q3 16 Basic
91,059
9,331
Fully Diluted
102,303
11,244
Source: Company filings.
*Some estimation required.
Dilution
24.1%
50.6%
67.8%
88.6%
II. Dan Rosensweigs dubious leadership track record

A focal theme of the CHGG bull thesis is that company management has created value for
shareholders in past endeavors. For example, a BMO Capital Markets report stated, We
believe Chegg has a very solid management team with a demonstrated track record of success.
We note several members of the management team have occupied high positions in very
successful Silicon Valley tech companies, including the companys CEO, Dan Rosensweig,
who previously worked as the chief operating officer of Yahoo!11
The facts would suggest managements achievements warrant extreme caution. Prior to
becoming CHGGs CEO, Mr. Rosensweig held leadership roles at three companies ZDNet,
the technology news and information site, Yahoo!, and Guitar Hero. We believe Mr.
Rosensweig unambiguously destroyed shareholder value at each of his prior companies and
the recent CHGG promotion appears to mirror the value destroying playbook of his past
ventures.
From 1997 2000, Mr. Rosensweig was President and CEO of ZDNet, which he took public
in March 1999. In a sign of the times, ZDNets share price nearly doubled in its first day of
trading, closing at $36.00 from a $19.00 IPO price.12 The stock would never again reach this
level. In an eerily similar pattern to CHGG, ZDNet commenced a reorganization and business
pivot shortly after its IPO. Also mirroring CHGGs strategy of obfuscating organic growth,
Mr. Rosensweig quickly acquired six companies in the span of just nine months.13 ZDNet
investors did not fall for Mr. Rosensweigs hollow strategy. During the greatest bubble of our
lifetime, when companies like Webvan raised hundreds-of- millions of dollars without
sustainable business models, ZDNets stock price declined by 75%. 14 , 15 According to
Advertising Age, ZDNet's investors have battered the stock in part because no one seems to
know what the company will be when all is said and done. 16 While it might sound
convenient to use the internet bubble crash as a scapegoat for Mr. Rosensweigs failures at
ZDNet, we would point out that the during the time period ZDNet lost 75% of its value the
Nasdaq gained 61%.17
________________________________________________________________________12
-------------------------------------------------------------------
Source: CapitalIQ.
After the ZDNet debacle, Mr. Rosensweig joined Terry Semel in 2002 to transform Yahoo!
into a media business. Mr. Rosensweig served as COO at Yahoo! from 2002 to 2006, which
encompassed historic strategic blunders. During Mr. Rosensweigs tenure, Yahoo! (a) had the
chance to buy Google, (b) failed to buy Google, which subsequently usurped Yahoo!s search
dominance, (c) purchased Overture for $1.4 billion, (d) failed to integrate Overture
successfully, (e) failed on its opportunity to buy a start-up called Facebook for $1 billion, and
finally (f) was forced to undo its entire media strategy and revert back to Yahoo!s technology
roots.18 Mr. Rosensweig departed Yahoo! during a management shakeup in late 2006 that was
marked by investor and employee unrest.19 According to an Associated Press article at the
time, the reorganization represented Yahoos mea culpa for meandering aimlessly during the
past year, to the chagrin of investors and the delight of competitors like Google Inc. that lured
away online traffic and advertisers.20 In 2008, Business Insider ran an article titled, Was
Yahoos Terry Semel the Worst Internet CEO Ever? 21 If Mr. Semel was indeed in the
running for Worst Internet CEO Ever, what does that say about Mr. Rosensweig as COO?
Despite his poor track record at ZDNet and Yahoo!, Mr. Rosensweig was again given a
wonderful opportunity when he became CEO of Guitar Hero, which was at the time the
fastest-selling video game ever. The franchise recorded more than $1 billion in revenue in
2007 and was a consumer juggernaut.22 Enter Mr. Rosensweig, who stated when he joined
Guitar Hero, With a platform and content that universally engages a wide range of
audiences, Guitar Hero has incredible growth potential. I look forward to continuing to
develop Guitar Hero into an even more successful enterprise.23 His new employer, Guitar
Heros parent Activision Blizzard, was equally enthusiastic about Mr. Rosensweig,
proclaiming, We are looking forward to leveraging [Rosensweigs] proven online experience
to build upon the billions of hours of entertainment we deliver each year in the Guitar Hero
network.24
________________________________________________________________________13
------------------------------------------------------------------After joining Guitar Hero, Mr. Rosensweig embarked on a process to expand distribution
through new business partners and spin-offs, such as DJ Hero and Band Hero.25 It would be
an understatement to say Rosensweigs strategy was not successful. In less than a year, the
Guitar Hero juggernaut was experiencing rapid sales declines and Mr. Rosensweig quickly
departed. 26 In 2011, Activision Blizzard was forced to shutter the entire Guitar Hero
division.27
2) CHGGs textbook rental business is commoditized & faces increased

competition
As we move ahead, our textbook business by design will become a smaller part of our
overall company, and we are still able to glean great value from it. Our strategy is to use our
Required Materials business to build our brand, grow our reach, and acquire customers
profitably, enabling us to more efficiently introduce our higher growth and higher margin
services that students love. And as you can see from our results, it's working.
Dan Rosensweig, 2/22/16
Most education technology companies struggle because the unit economics for studentdependent businesses are often unprofitable. Specifically, the cost to acquire a studentcustomer is generally higher than the lifetime value of that customer. CHGG historically has
been no exception with its consistent GAAP, non-GAAP, and free cash flow losses. However,
the new promote argues that CHGG can use its commoditized textbook rental business to
funnel customers into its higher margin digital services segment. The bulls argue that
CHGGs textbook rental business, despite atrocious standalone unit economics, can lower the
companys digital services lead generation costs compared to the plethora of other education
technology providers. Like much of the CHGG promote, the story is not supported by the
facts. As discussed below, CHGGs textbook rental business is not self-sustaining and Chegg
Services is in fact neither a high growth, nor high margin business.
CHGGs textbook rental business has been renamed Required Materials. As seen in the
table below, the business has transitioned from decelerating growth to a nearly 10% structural
decline based on managements 2016 guidance.
CHGG Required Materials Analysis
$ 000s
2012
2013
2014
Pro Forma Required Materials Revenue
45,900
57,192
66,111
YoY Growth
24.6%
15.6%
Source: Company filings. 2016 based on midpoint of pro forma guidance.
2015
71,818
8.6%
2016G
65,500
(8.8%)
2017G
58,000
(11.5%)
When CHGG initially introduced its textbook rental offering in 2007, the concept was
revolutionary. 28 CHGG disrupted the prior model that forced college students to purchase
expensive, single use textbooks. Ten years ago, students paid approximately $1,200 per year
for textbooks and that cost has increased by nearly 50% over the last decade.29 CHGG had an
innovative model and a first mover advantage that resulted in revenue that grew from
________________________________________________________________________14
------------------------------------------------------------------essentially zero in 2007 to nearly $150 million by 2010.30 [Like most uneconomical models,
CHGGs losses grew at a faster rate than revenue, but that is beside the point.]
CHGGs impressive revenue growth attracted significant competition. Numerous upstart
competitors entered the market, with sites such as AbeBooks, Half.com, ValoreBooks,
eCampus, BookRenter, Textbooks.com, and Boundless all entering CHGGs market; it is
abundantly clear there are no barriers to entry for textbook rentals. CHGGs first mover
advantage was unsustainable given the lack of product differentiation (an intermediate
accounting textbook from CHGG is substantially similar to the same intermediate accounting
book from BookRenter or Half.com). In addition to intense direct competition, comparison
shopping sites such as dealoz.com, textbookrentals.com, TextSurf, and StudentRate began to
appear, which allowed students to compare rental sites for the best price.
Next, while limited brand differentiation and zero sustainable barriers to entry destroyed
most, if not all, economic profit potential among mono-line textbook rental companies,
Amazons entry into the market in further assured CHGGs demise. After launching a digital
textbook rental service in 2011, Amazon quickly followed with a full-scale physical textbook
rental program in 2012. Unsurprisingly, Amazons size, scale, and technological advantages
destroyed the incumbents. According to Uwire, a popular college student website, Amazon is
already considered one of the best places to buy or rent textbooks:
Through Amazon, students are able to order books based on condition, price and shipping.
Students can also order Kindle versions of textbooks, which can be used through the free
Kindle app. Book rentals are also provided and are priced based on how long one plans to
use the textbooks. Amazon provides students with one of the most cost effective routes for
purchasing or renting textbooks.
Today, CHGG is rarely the low cost option for students. For example, the textbook
Intermediate Accounting rents for $320.95, which is 123% more expensive than the lowest
cost option from knetbooks. Additionally, CHGGs most popular textbook, Campbell
Biology, also illustrates the price uncompetitive nature of CHGGs textbook rental
business.
Comparison Rental Pricing for Intermediate Accounting
________________________________________________________________________15
-------------------------------------------------------------------
Source: dealoz.com, accessed 8/24/16. Rental prices may vary throughout a semester.
Comparison Rental Pricing for Campbell Biology
Source: dealoz.com, accessed 8/26/16. Rental prices may vary throughout a semester.
CHGGs inability to compete in the rental textbook market, as evidenced by managements

implied ~10% revenue decline and basic comparison shopping, represents a clear indication
this segment is not a sustainable source of low cost customer acquisition for the companys
digital services. Additionally, we believe competition is poised to become even more intense.
Barnes & Noble Education (BNED), which operates over 750 college bookstores and related
e-commerce sites, piloted a price-match program at 70-80 schools in 2015. Based on its
________________________________________________________________________16
------------------------------------------------------------------success, BNED recently announced the price-match program will be expanding in 2016 to the
majority of its campus bookstores.31 The program offers student a refund during the first week
of class if they find a lower price on used, new, or rental textbooks.32 CHGG will face the full
brunt of the implementation of this program in Q416, which could explain managements
implied guidance for Required Materials to decline by nearly 40% in Q416.
Amazon is also increasingly focused on attracting college student customers by rolling out
branded mailrooms on university campuses. The program, called Campus Pick-up Point,
was initially piloted in 2015 at Purdue University as a service for students who live in dorms
or apartments, where receiving packages can be challenging.33 In 2016, Amazon is expanding
the program to the University of California at Davis, the University of California at Berkeley,
the University of Texas at Austin, the University of Massachusetts at Amherst, the Georgia
Institute of Technology, and the University of Pennsylvania. 34 Amazon also has plans for
several more pickup points on or near other university campuses.35 As part of the program,
universities receive 2% of every Amazon purchase delivered, further aligning interests around
the program.36
And just last month, Pearson, one of the largest textbook publishers in the country, announced
a partnership with Follett Higher Education, the largest campus retailer nationwide. The
partnership will provide Folletts 1,200 campus bookstores nationwide access to Pearsons
Digital Direct Access model, which is a suite of e-textbooks and other digital content.37 Tom
Malek, Senior Vice President of Partnerships at Pearson, stated, By partnering with Follett,
were making these pricing and delivery models available to all of Folletts partners,
increasing student affordability and access, and improving faculty access to real-time data and
analytics.38
Given substantial and increasing competition in the textbook rental market, we believe
CHGGs purported low cost customer acquisition channel doesnt have a chance to compete
successfully.
3) Chegg Services stability, margins, and growth characteristics are

misrepresented
I. Chegg Services faces persistently high customer churn
The vast majority of CHGGs businesses target college students (Chegg Study, Chegg Tutors,
and Internships.com are all higher education focused). Assuming the average college student
is enrolled for four years, CHGG numerically has at least 25% of its customers churning
annually (assume cohort linearity). We believe actual annual churn is closer to 100%.
Management often highlights Chegg Studys high renewal rate. In its most recent quarter,
CHGG reported an 80% renewal rate for this segment.39 While this renewal rate may appear
respectable, the fine print discloses CHGGs renewal rate is actually the monthly renewal rate
for the quarter. As such, CHGGs renewal rate is closer to 7% on an annualized basis.
Obviously, this means CHGG must replace 93% of its customers every year.
________________________________________________________________________17
------------------------------------------------------------------We readily admit that while the table below is correct for a steady cohort, the analysis is
imperfect. Students may cancel their CHGG memberships at different points (e.g., over the
summer or winter holidays) and re-enroll later. However, no matter how the data is sliced, the
80% monthly renewal rate, or 20% monthly churn, creates retention challenges that are
typically only found in the online dating industry.
Chegg Study Renewal Rate Analysis
Month
Students
Monthly Renewal Rate
0
100
80%
1
80
80%
2
64
80%
3
51
80%
4
41
80%
5
33
80%
6
26
80%
7
21
80%
8
17
80%
9
13
80%
Annual Renewal Rate

Source: CHGG Q3'16 earnings release and internal analysis.
10
11
80%
11
9
80%
12
7
80%
7%
II. Chegg Tutors pricing implies management misrepresented gross margins

CHGG management has consistently stated that the companys digital services segment is a
higher growth, higher margin business compared to textbook rentals. According to
management, CHGG will have gross margins of at least 60% when the company reaches its
target operating model (we discuss later how management quietly pushed out its target model
by a year). Management has also stated Chegg Tutors is its fastest growing segment and will
be the fastest segment to reach $100 million in revenue despite de minimis revenue today.40
The inference is that the drive towards 60% gross margins will be driven by the fastest
growing segment, Chegg Tutors, which mathematically would require gross margins well in
excess of the overall target model of 60%. However, the implied math driving managements
future promises appears faulty.
CHGG pays its tutors $20 per hour.41 As can be seen below, the standard pricing for Chegg
Tutors is $30 per hour.42 (30 minutes at $15 per week plus 50 cents for each additional minute
equates to $30/hour) Making the laughable assumption that revenue from Chegg Tutors
carries no incremental costs like hosting, technology, or customer care, advertised gross
margin would be only 33%. It is unclear how these publicly advertised figures reconcile with
managements story of 60%+ gross margins.
________________________________________________________________________18
-------------------------------------------------------------------
Source: https://www.chegg.com/tutors/pricing/
III. Management has historically squandered shareholder capital through poor acquisitions
In a repeat of Mr. Rosensweigs playbook from ZDNet, CHGG has chased revenue growth
through murky acquisitions. In the last six years, CHGG has completed at least 10
acquisitions. We believe every current digital services offering came by way of acquisition, as
CHGG has not developed a single product internally. This begs the question, on what exactly
did CHGG spend $60 million in 2015 for technology and development?
Contrary to managements claim that its acquisition strategy has been a success, we believe
Cramster, which was renamed Chegg Study, is the only acquisition that has performed to plan.
Four of the ten products/companies acquired by CHGG have subsequently been shut down or
discontinued, while three others are behind plan. While it is too early to determine whether
Imagine Easy will be a success, the $139 million of wasteful acquisition expenditures to date
bode poorly for the return on the incremental $35 million of earn-out payments.
CHGG Acquisition Analysis
$ 000s
Target
Date
Price
CHGG Product
Courserank
8/19/10
N/A
Course Reviews
Cramster
12/8/10
N/A
Chegg Study
Notehall
6/22/11
4,700
N/A
Student of Fortune
8/23/11
5,200
N/A
Zinch
10/6/11
27,200
Enrollment Marketing
Bookstep
3/7/14
3,000
N/A
CampusSpecial
4/9/14
16,000
Chegg Deals
InstaEDU
6/5/14
30,000
Chegg Tutors
Internships.com
10/2/14
11,000
Careers
Imagine Easy
5/1/16
42,000
Writing Tools
Total
139,100
Source: Company filings, management commentary, and Factiva.
Commentary
Discontinued
Performing well
Discontinued
Discontinued
Reset growth expectations Q3 14
Never provided
Discontinued
Behind plan as of Q4 15
No monetization until 2017
???
________________________________________________________________________19
------------------------------------------------------------------IV. Chegg Services subscriber growth is significantly overstated

While CHGG management has recently touted its strong subscriber growth as a key metric for
business momentum, this metric is never actually defined nor is it included in a single formal
SEC filing. If this metric is indeed important for investors and analysts to evaluate
managements progress, why would management exclude it from its formal filings with the
SEC?
We believe the answer is because management consistently alters the metric to fit its shifting
narrative. For example, in Q315 management reported 825,000 digital subscribers,
representing 23% year-over-year growth. However, management reported 800,000
subscribers in Q316, which they claimed represented over 40% year-over-year growth.
Shrinking subscribers from 825,000 to 800,000 would seem to represent 3% contraction, NOT
40% growth.
Source: Q315 CHGG earnings press release.
Source: Q316 CHGG earnings press release.
As part of CHGGs shifting segment disclosures (which we discuss in detail below), we

believe management also altered its definition of a subscriber. Based on our understanding of
CHGGs revised reporting, the companys subscriber count conveniently no longer includes
eTextbook customers (which is now in decline). Fortunately, because management provided
historical CHGG Services subscribers for the first time in its Q316 data sheet, we can
calculate implied historical eTextbook customers. Next, if we assume these customers
grow/decline at the same rate as overall Required Materials (the segment to which eTextbooks
was shifted in order to inflate perceived digital growth), we can calculate a normalized digital
subscriber metric. Finally, because CHGG acquired Imagine Easy in Q216, we must
therefore remove an estimate for these customers. As can be seen in the analysis below, we
believe organic digital subscriber growth has been quickly decelerating throughout 2016.
________________________________________________________________________20
------------------------------------------------------------------CHGG Subscriber Analysis

Q1 15
Q2 15
Q3 15
750,000
550,000
200,000
700,000
540,000
160,000
825,000
560,000
265,000
Normalized Digital Subscribers

750,000
Imagine Easy Subscriber Estimate
Organic Digial Subscribers

750,000
YoY Growth
Source: Company filings and internal estimates.
700,000
700,000
825,000
825,000
Reported Digital Subscribers

Revised Chegg Services Subscribers
Implied/Est. eTextbook Customers
YoY Growth
Q1 16
Q2 16
Q3 16
750,000
182,218
(8.9%)
760,000
153,642
(4.0%)
800,000
275,345
3.9%
932,218
932,218
24.3%
913,642
75,000
838,642
19.8%
1,075,345
125,000
950,345
15.2%
4) CHGG has consistently misrepresented its financial & segment

reporting
1. Management has repeatedly reorganized reporting segments to artificially inflate digital
growth
In the ~3 years since CHGG has gone public, management has reported company revenue
under three different derivations. We believe the primary goal of constantly reshuffling
revenue segments is to obfuscate the companys poor results.
At the time of its IPO, CHGG had two straightforward revenue categories Print
Textbooks and Non-print Products and Services. Print Textbooks represented the slower
growth textbook rental business while Non-print Products and Services represented the
companys faster growing eTextbook, subscription, and advertising segments.
CHGG Revenue Classifications
Period
At IPO
Revenue Classification
Print Textbooks
Non-print Products and Services
Description
Online print textbook rentals
eTextbooks, subscription services, and enrollment marketing
2015
Print Textbooks
Digital Offerings
Rental or sale of print textbooks

Connected learning platform, eTextbooks, online tutoring, Chegg Study, College
Admissions, Scholarship Services, and internship services + Ingram commission revenues
2016
Required Materials
Chegg Services
Print textbooks, eTextbooks, and Ingram commission revenues

Chegg Study, Chegg Tutors, Enrollment Marketing, Brand Partnerships, Writing Tools and
Careers
In 2015, management reorganized its reporting segments to include Print Textbooks and
Digital Offerings. While the change appeared innocuous, we believe the modification
contained details that had the undeniable impact of overstating digital segment growth. As
discussed in more detail below (and has garnered specific SEC attention), management
________________________________________________________________________21
------------------------------------------------------------------attributed Ingram commissions from print textbooks rentals to the companys digital
revenue group. While there was no net impact to consolidated revenue, the categorization of
print textbook rental commissions as digital revenue undeniably overstated digital growth,
which has become the most important metric for the investment community.
We believe the reporting reorganization in 2016 was an even more duplicitous attempt to hide
weak performance and further manipulate digital revenue growth. Management once again
changed CHGGs revenue segments, this time to Required Materials and Chegg Services.
Under the newest iteration, management shifted both its Ingram textbook rental commissions
and its eTextbooks revenues to Required Materials (formerly Print Textbooks).
Previously, both eTextbooks and the Ingram commissions had been classified under digital
services revenue. The attribution reconfiguration of these two sub-segments had the effect of
overstating year-over-year comparisons for digital revenues not once, but twice (as seen in the
illustration below).
In 2015, nearly all of the commission revenue from Ingram was new compared to the
previous year (the program was piloted in late 2014 and fully rolled out in 2015). Therefore,
including Ingram commissions (front print textbook rentals) as digital revenue vastly
improved the growth profile for this segment in 2015. However, these commissions would
need to be lapped in 2016, which would have created a challenging comparison for digital
growth. Supporting our belief that management manipulated its segment reporting, the
company moved the Ingram commissions out of digital (the segment management believed to
be appropriate in 2015) and into Required Materials in 2016. The net effect was that the
new Chegg Services segment faced a remarkably easier comparison in 2016.
In addition to shifting CHGGs Ingram commission revenue, management also inexplicably
removed its eTextbook business from the companys digital revenue category. Given
________________________________________________________________________22
------------------------------------------------------------------eTextbooks is a 100% digital business, why would management feel compelled to make this
arbitrary change? We believe the shift was a blatant attempt to hide slowing digital growth.
CHGGs eTextbook segment had historically been a fast growth business based on market
share gains versus print textbooks. However, in late 2015 publishers raised the relative prices
for eTextbooks (compared to print textbooks), which significantly curtailed eTextbook
growth. According to management, eTextbook unit growth was greater than 60% in 2014.43
However, because of the publisher pricing changes, management expected eTextbook revenue
to decline in 2016.44 As such, similar to managements conundrum regarding the companys
Ingram commissions, eTextbooks would become an unwelcome drag on digital revenue
growth in 2016. We believe the reason for the unorthodox maneuvers by management is
crystal clear: move eTextbooks and Ingram commissions to Print Textbooks (now Required
Materials) to hide the rapid deceleration of Digital revenue (now Chegg Services).
II. Normalized digital revenue growth is significantly below managements target
Our digital businesses are expected to grow better than 60% in Q4 and we anticipate
similar growth in 2015.
Andy Brown, CHGG CFO, Q314 earnings call, 11/3/14
As discussed above, we believe CHGG management reorganized its reporting segments to
hide slowing growth in its all-important digital segment. We also believe actual digital growth
is a fraction of what CHGG has represented publicly. At the end of 2014, management
unequivocally stated that it expected digital revenue to grow at least 60% in 2015, which was
prior to Ingram commission revenue shifting from print to digital. In fact, when asked in the
conference calls Q&A about this exact topic, (whether 60% forecast included or excluded
Ingram), CFO Brown unmistakably stated:
Question Douglas T. Anmuth: And can I just follow up on 2015, the 60% digital
growth number that you mentioned. Does that include and make some assumption for
how much of for a part of the business that is, of course, moving over to Ingram and
has revenues getting booked in digital?
Answer Andrew J. Brown: No Doug, it doesn'tanything that Ingram adds would
just be bigger [and] that would add to that total.45
Despite (a) the benefit of multiple acquisitions throughout 2014 that would have aided the
2015 year-over-year growth rate, and (b) shifting Ingram print textbook commissions to the
digital segment, CHGGs digital revenue slowed substantially in 2015 and was well below
managements stated target that excluded the large benefit that was ultimately received from
the Ingram segment reorganization.
________________________________________________________________________23
------------------------------------------------------------------CHGG Digital Revenue Growth

$ 000s
Reported Digital Revenue

YoY Growth
2013
2014
2015
52,498
91,177
73.7%
140,005
53.6%
Entering 2016, CHGG was already behind its targeted growth plan and now faced the
difficulties of lapping its Ingram commission benefit. Management had committed to
substantial growth that would not be achievable. Rather than candidly address the
disappointing digital growth, as discussed above management again altered CHGGs revenue
reporting segments. We have not seen one sell-side report that identified managements
changes or attempts to independently analyze the actual growth rate of CHGGs digital
business. However, an estimate for the digital growth rate can be calculated.
Chegg Services revenue is simply the former digital revenue segment excluding the
companys Ingram commission and eTextbooks. We can therefore calculate historical implied
revenue for these sub-segments by deducting restated Chegg Services revenue from originally
reported Digital revenue. Next, if we assume revenue from Ingram and eTextbooks declines
in 2016 at the same rate as the overall guidance for Required Materials, we can determine
2016 estimated revenue for Ingram and eTextbooks. With this straightforward calculation, we
can create a clean compare for digital revenue growth by adding Ingram commissions and
eTextbooks to managements guidance for Chegg Services. The math is scary and illustrates
why we believe management has gone to such great lengths to avoid straightforward
reporting. Using the companys own segments, financials, and guidance, normalized digital
revenue growth will be just 16% in 2016. As discussed above, we believe the substantial
deceleration in digital revenue growth is the primary driver for managements unjustifiable
changes to its revenue reporting segments and altered long-term targets. Above all else, with a
16% normalized digital revenue growth rate, we believe the company will not achieve
managements 2017 guidance (which itself is already below prior consensus estimates).
________________________________________________________________________24
------------------------------------------------------------------CHGG Normalized Digital Revenue Growth

$ 000s
Reported Digital Revenue

Restated Chegg Services Revenue
Implied Ingram + eTextbooks
YoY Growth
2013
2014
2015
52,498
41,830
10,668
91,177
68,117
23,060
116.2%
140,005
94,286
45,719
98.3%
2016E
41,697
(8.8%)
Chegg Services Guidance (excluding ImagineEasy)

120,500
Ingram + eTextbook Estimate
41,697
Normalized Digital Revenue
52,498
91,177
140,005
162,197
YoY Growth
73.7%
53.6%
15.9%
Ingram + eTextbooks 2016 estimated decline in-line with management's guidance for Required
Materials.
III. Multiple revenue reclassifications have discrepancies with reported pro forma financials
Possibly because CHGG management has reclassified revenue so many times, or because of
creative retroactive changes to PowerPoint slides that artificially inflate current-year revenue
growth, historical pro-forma revenue disclosures fail to reconcile. For example, in an IR
presentation from August 2015, CHGG reported 2014 pro forma revenue of $142.7 million,
implying 2014 growth of 40% compared to $101.9 million in 2013. Just six months later, in
CHGGs 2016 IR presentation, the historical 2014 revenue was revised down by 6% to $134
million ($66M + $68M).
Perhaps the revenue changes were a mistake, but the lower 2014 revenue baseline obviously
flatters the 2015 growth rate. We have been unable to find any disclosure or explanation for
the change and it remains unclear why historical revenue would change well over a year after
it was initially reported. Based on what we believe to be a consistent pattern of
misrepresentation and misleading reporting, we would point out that the 2014 revenue
alteration resulted in 24% reported growth for 2015, as opposed to only 16% growth had the
originally reported revenue figures been maintained.
________________________________________________________________________25
-------------------------------------------------------------------
Source: CHGG IR Presentation, 8/4/15
Source: CHGG IR Presentation, 2/22/16
IV. The SEC requested information regarding CHGGs revenue reclassifications
Source: https://www.sec.gov/Archives/edgar/data/1364954/000000000015056977/filename1.pdf
If not clear by now, we believe CHGGs multiple revenue reclassifications and dubious
presentation of textbook rental commissions as digital are highly misleading. On December
8, 2015, the SEC sent a letter to Mr. Rosensweig, which appeared to focus on CHGGs digital
revenue classification.46 Specifically, the SEC inquired, Please tell us how you determined
commission fees related to the Ingram Content Group (Ingram) partnership, where Ingram
fulfills print text book transactions, are most appropriately presented as revenue from Digital
offerings.47
Less than two weeks later, CHGG responded with a vigorous defense, despite openly
conceding that the Ingram commissions are tied to physical product sales:
Response: Chegg respectfully advises the Staff that, although the product delivered by
the Ingram Content Group (Ingram) is physical in nature, Chegg provides a digital
service through its website by serving as the interface between the student and Ingram.
The marketplace service that Chegg provides is similar regardless of whether the
textbook is print or digital. When a student places an order on the Chegg.com website
for a textbook that is owned by Ingram, Chegg facilitates the transaction between the
student and Ingram but Ingram fulfills the rental textbook order. Chegg never takes
possession of the textbook; rather we offer a textbook owned by Ingram for rental by a
student. All of the activities required for Chegg to earn its commission from Ingram
are executed through the Chegg website and are digital, and thus we have determined
________________________________________________________________________26
------------------------------------------------------------------to be similar in nature. Based on these considerations, Chegg records the commission
fees earned from Ingram on the transaction as component of digital revenue on its
Consolidated Statement of Operations. We continue to record revenue earned in
connection with orders of print textbooks owned by Chegg as a component of print
revenue. This differentiation of print versus digital revenue is useful to our investors
as it provides a view into our transition from owning a capital intensive print textbook
business to a fully digital business. This allows investors to properly model Cheggs
go-forward business.48
Despite vehemently defending its revenue characterization to the SEC on December 21, 2015,
management took the unusual step of completely reversing course and removing Ingram
commissions from its digital segment when it provided guidance for 2016. Concomitant with
this illogical step (based on the justification provided months earlier to the SEC), management
reclassified its Ingram commission revenue and renamed its segments Chegg Services and
Required Materials. On CHGGs Q415 earnings call, the companys CFO Andy Brown
stated, We will also be reporting and guiding separately on total Required Materials which
includes revenue from textbooks, eTextbooks as well as the Ingram commission. We are
doing this to increase transparency into our slow growth business, but more importantly it
matches the way students come to Chegg to search for textbooks and our goal is providing
students the textbooks they need in the format they want.49
While the explanation and new segment names implied broad changes, the only effective
modifications were to remove eTextbook and Ingram commissions from digital (both of
which are now in decline). Interestingly, when a sell-side analyst asked a question regarding
the reclassification, management admitted the change was driven entirely by the motivation to
remove Ingram commissions and eTextbooks from the digital segment:
So what's in the Required Materials is this. It is all of the Ingram commission, all of
the print books that we deliver, and all of the eTextbooks. And so essentially what is
done and let me put it in a different format. If you take what our Digital revenue was
last year, take out the Ingram commission and take out eTextbooks and put it with our
print, that gives you Required Materials. That's how it works. Andy Brown, CHGG
CFO, 2/22/16
Managements staunch defense to the SEC, which was immediately followed by another resegmentation, adds further support to our belief Messrs. Rosensweig and Brown orchestrated
their segment reporting in a misleading and inappropriate manner to overstate digital revenue.
V. Did CHGGs inventory transfer sales to Ingram artificially inflate revenue?
In August 2014, CHGG announced a strategic alliance with Ingram Content Group. Under the
agreement, CHGG would continue to market textbooks and provide customer service, while
Ingram would be responsible for textbook inventory, fulfillment, shipping, and returns. As
part of the deal, CHGG would transfer its textbook inventory to Ingram at cost.50 While the
transaction would clearly impact CHGGs balance sheet (debit to cash or accounts receivable
________________________________________________________________________27
------------------------------------------------------------------and credit to inventory), the inventory transfer created no economic benefit and thus should
have had a non-recurring impact on CHGGs income statement. However, we believe these
transitory inventory transfers, which should have been recorded as one-time gains/losses,
were instead included as profitless revenue as yet one more mechanism to inflate perceived
growth. On CHGGs GAAP income statement (which unsurprisingly is not discussed by
management), the company reports three revenue line items:
1.
2.
3.
Rental rental of print textbooks

Services Chegg Study, brand advertising, eTextbooks, tutoring, enrollment
marketing, and commerce
Sales just-in-time sale of print textbooks and the sale of other required materials
Based on the companys business drivers, rental revenue (1) and sales revenue (3) should be
highly correlated as both segments are tied to student demand for physical textbooks. Each
year, some students rent textbooks, while others purchase course materials. However, growth
in these two segments diverged significantly in 2014 and 2015, which coincided with
CHGGs Ingram alliance. In 2014, rental revenue declined by 4%, yet sales revenue increased
by 145%. Management did not bother to discuss this unique development and revenue driver.
CHGG "Sales" Revenue Analysis
$ 000s
2013
GAAP Rental Revenue
189,004
GAAP Sales Revenue
14,613
Rental Revenue Growth
Sales Revenue Growth
2014
181,570
35,804
2015
120,365
49,012
(3.9%)
145.0%
(33.7%)
36.9%
YTD 15
93,199
46,019
YTD 16
32,081
32,157
(65.6%)
(30.1%)
What is more confounding than the revenue growth variance is the profit (or lack thereof)
generated on the Sales increase. In 2015, gross margin on sales revenue was only 2% and
year-to-date 2016 gross margin is negative 5%, which implies CHGG generates essentially
zero incremental profit on these transactions and thus further demonstrates the impressive
revenue growth may have been a function of profitless textbook inventory sales to Ingram.
VI. CHGG appears to be in direct violation with SEC Regulation G
The SEC implemented Regulation G in 2003 to prohibit material misstatements or omissions
that would make the presentation of a non-GAAP financial measure misleading to investors.51
Earlier this year, the SEC issued new Compliance and Disclosure Interpretations (C&DIs)
regarding the use of non-GAAP financial measures to further curb perceived abuse. 52
Specifically, the updated C&DIs state, a non-GAAP measure that is adjusted only for nonrecurring charges when there were non-recurring gains that occurred during the same period
could violate Rule 100(b) of Regulation G. 53 The SEC is effectively telling management
teams they may not exclude one-time charges while also including one-time gains when
reporting non-GAAP measures.
________________________________________________________________________28
------------------------------------------------------------------Despite the SECs clear guidelines, CHGG management appears to continue its disregard for
regulatory reporting requirements. Specifically, for 10 straight quarters CHGGs management
has excluded acquisition-related compensation (which is clearly recurring at this point),
restructuring charges, and other one-time expenses from its adjusted EBITDA calculation.
Striking at the heart of the SECs newest C&DIs, CHGG has simultaneously included onetime gains repeatedly on the liquidation of textbooks. What is also noteworthy is that CHGGs
supposed one-time adjustments have grown from $1.2 million in 2013 to $12.2 million in
2015.
CHGG "One-Time" Gains and Losses
$ 000s
EBIT - excluding gains on textbook liquidations

D&A
Stock-based compensation
EBITDA
Gain on textbook liquidations
Acquisition-related compensation, restructuring,
and other "one-time" expenses
Total adjustments
Company reported adjusted EBITDA
2013
2014
2015
YTD 16
(52,217)
10,078
36,958
(5,181)
(69,689)
11,160
36,888
(21,641)
(57,158)
11,511
38,775
(6,872)
(39,817)
10,001
32,701
2,885
1,186
4,555
4,326
523
1,186
4,135
8,690
7,904
12,230
3,488
4,011
(3,995)
(12,951)
5,358
6,896
In addition to CHGGs abuse of non-GAAP profit adjustments, we believe management has

also violated Regulation G regarding its opaque non-GAAP pro forma revenue metric.
According to the SEC, Regulation G requires the registrant to provide a reconciliation (by
schedule or other clearly understandable method), which shall be quantitative for historic
measures and quantitative, to the extent available without unreasonable efforts, for
prospective measures, of the differences between the non-GAAP financial measure presented
and the most directly comparable financial measure or measures calculated and presented in
accordance with GAAP.54
In the midst of its promotional business model pivot, CHGG continues to rent its own
textbook inventory (for which the company receives 100% of revenue), while also receiving
commissions for orders that are fulfilled by Ingram. Management has publicly stated CHGG
receives an approximate 20% commission for each Ingram transaction.55 Thus, while CHGG
is undergoing its transition, management is reporting pro forma revenue metrics as if
Ingram already owned all textbooks. Considering management has disclosed the Ingram
commission, an as if revenue reconciliation table reconciling GAAP to non-GAAP revenue
that is clearly understandable and quantitative should not be difficult. Nonetheless,
CHGGs quarterly earnings press releases provide one line item titled Adjustments. What
exactly these adjustments entail, and how they are calculated, is unclear. In fact, as shown
extensively above, CHGGs adjusted results change without explanation. In early 2015,
________________________________________________________________________29
------------------------------------------------------------------management introduced certain pro forma metrics to assist investors in understanding the
business model shift. Those same adjustments are now periodically included by management
in certain quarters, while excluded altogether in others.56
5) Managements egregious compensation & other conflicts of interest

I. Abusive stock compensation transfers value from investors to management
CHGGs stock-based compensation represents an astounding 28% of revenue. Across a broad
spectrum of education businesses, marketplaces, and consumer internet companies, average
stock-based compensation expense as a percent of revenue is less than 4%. While we would
gladly debate whether stock based compensation should be considered an expense (yes, it
should), that is not the point. CHGGs rate of spend on stock compensation is not even
comparable to the companys education-focused peers, which typically spend less than 1% of
revenue on stock comp. CHGGs stock based compensation expense is also many multiples
higher than that of its technology peers, which are generally known for aggressive stock
compensation in the first place. The only company we could find with remotely similar stock
compensation to CHGG as a percent of revenue is Twitter (TWTR).
Incredibly, despite outlandish levels of non-cash stock compensation expense, CHGG
continues to burn cash (more on cash flow below). [in the table below we generously included
LinkedIn in an effort to expand the peer group, although few would find the actual
comparison fair]
CHGG Stock-based Compensation Analysis
$ 000s
Company Name
Barnes & Noble Education Inc
Barnes & Noble Inc
Scholastic Corp
Houghton Mifflin Harcourt Co
Amazon.com Inc
K12 Inc
IAC/InterActiveCorp
Groupon Inc
Angie's List Inc
eBay Inc
LinkedIn Corp
Mean
Median
Ticker
BNED
BKS
SCHL
HMHC
AMZN
LRN
IAC
GRPN
ANGI
EBAY
LNKD
Market
Cap
458,886
801,734
1,425,076
1,359,241
352,754,126
535,875
5,187,939
2,322,926
456,666
31,480,809
25,887,986
YTD 16
Revenue
1,513,270
3,287,160
1,159,000
1,130,879
92,246,000
651,381
2,328,720
2,208,469
246,661
6,584,000
2,753,151
YTD 16 Stock Comp

Stock Comp
% of Rev
4,817
0.3%
10,943
0.3%
8,100
0.7%
8,754
0.8%
2,088,000
2.3%
16,241
2.5%
82,610
3.5%
94,750
4.3%
10,752
4.4%
307,000
4.7%
432,014
15.7%
3.6%
2.5%
Chegg Inc
CHGG
812,286
143,023
32,701
Source: Bloomberg and company filings.
CHGG YTD 16 revenue based on pro forma information provided by management.
22.9%
________________________________________________________________________30
------------------------------------------------------------------Because of CHGGs excessive stock compensation, the gap between basic and diluted shares
outstanding has a material impact when analyzing the companys market capitalization and
enterprise value. CHGG has nearly 16 million shares that would be included in its diluted
share count in the unlikely event the company ever achieves profitability, or the even less
likely event the company were to be acquired. Stock compensation (options, RSUs and PSUs)
does not impact CHGGs adjusted income statement and these potentially dilutive shares are
excluded from analyst models and adjusted financial results.
Source: CHGG Q316 10-Q.
II. Managements excessive pay is not tied to performance

All or a portion of 50% of the shares subject to these PSU awards may have been earned
upon our achievement of digital revenue, digital revenue net the commission earned from
Ingram and free cash flow performance targets by December 31, 2015 that were approved by
the compensation committee and subject to the compensation committees determination that
such targets were achieved, in full or in part, following the completion of the 2015 fiscal year.
The targets for each of these performance measures for 2015 was $143.6 million for digital
revenue, $135.9 million for digital revenue net the commission earned from Ingram and $26
million for free cash flow. CHGG 2016 Proxy Statement
CHGGs Board of Directors is comprised of multiple venture investors and friends of the
CEO. Considering the potential conflicts this coziness could present, we were surprised to see
CHGG neglect to provide a Compensation Discussion and Analysis section in its proxy
statement. The lack of disclosure and accountability extends well beyond compensation.
CHGG does not provide a list of peers, it does not provide a conceptual discussion about
compensation for its executive team, and it does not disclose how the company performed
relative to its performance-based metrics.
We are not owners of CHGG, so we are agnostic about the companys poor governance
policies. However, we would point out that in 2015, CHGG did not achieve a single
performance-based target that was outlined in the companys Proxy Statement. Additionally,
total shareholder return, as defined by the CHGGs stock price performance, was negative
2.6%. For this utter lack of shareholder value creation, Mr. Rosensweigs Board awarded him
with nearly $10 million of stock grants. Institutional Shareholder Services (ISS) also took
issue with the excessive compensation, stating, The equity grant to CEO Rosensweig more
than doubled, resulting in pay and performance misalignment. No disclosure was provided
regarding a rationale for the increase in equity awarded.57
________________________________________________________________________31
-------------------------------------------------------------------
Source: CHGG 2016 Proxy Statement.
While half of Mr. Rosensweigs stock awards were performance-based, and therefore
technically should have been subject to meeting pre-defined performance targets, it appears
the compensation committee ignored these benchmarks. While CHGG did not achieve a
single performance-based metric in 2015, the compensation committee determined that 33%
of [Mr. Rosensweigs] PSUs were earned.58 No explanation was provided about why these
performance grants were issued.
Target
Actual
Digital revenue
$143.6mm
$140.0mm
Digital revenue net Ingram

commission
$135.9mm
N/A*
$26mm
($2.4)mm
Free cash flow
Achievement

*while management did not disclose Ingram commission, we note that rental revenue declined by ~61 million,
which implies $12 million Ingram commission.
Since CHGG went public three years ago, its stock price has declined by 45%,
underperforming the Russell 2000 by 60%. Further, management has repeatedly missed its
performance targets. Yet over the same period that shareholders have suffered immense
losses, Mr. Rosensweig has received nearly $24 million in total compensation.
CHGG CEO Compensation v. Stock Performance
$ 000s
2013
2014
CEO Compensation
8,970
4,990
CHGG Stock Performance
(31.9%)
Russell 2000
5.9%
Over / (Under) Performance
(37.8%)
Source: Company filings and Bloomberg.
(18.8%)
4.9%
(23.7%)
2015
9,837
2016
N/A
(2.6%)
(4.4%)
1.8%
13.2%
11.6%
1.6%
________________________________________________________________________32
------------------------------------------------------------------6) Weak operating performance, cash burn, & acquisition earn-outs impair
the balance sheet
I. Management has misrepresented recent business momentum
Like most stock promotes, managements public assessment of its financial performance is
often in stark contrast to an objective analysis of the financial accounts. In Q216, CHGG
management highlighted that EBITDA more than doubled compared to the prior year, with
the CFO proudly stating on the earnings call, as a result of the strong revenue and gross
margin performance, our adjusted EBITDA came in at $7.2 million, more than double the
prior year and another proof point that our new business model is working.59 What the CFO
failed to share was that excluding lumpy, non-recurring textbook sales, EBITDA would have
actually declined year-over-year. The benefit of selling textbook inventory for gains will
cease in 2017 as the Ingram inventory transfer is completed.
CHGG Adjusted EBITDA Analysis
$ 000s
Q2 15
(9,697)
3,241
(6,456)
Q2 16
(8,375)
3,491
(4,884)
Share-based Compensation
Restructuring Charges / (Credits)
Transitional Logistic Charges
Acquisition Related Compensation Costs
Total Adjustments
7,831
464
707
660
9,662
11,221
(154)
1,000
12,067
Company Reported EBITDA

(Gain) / Loss on Liquidation of Textbooks
Adjusted EBITDA
Source: Company Filings.
3,206
2,445
5,651
7,183
(2,191)
4,992
EBIT
Depreciation and Amortization Expense
EBITDA
II. Significant increases in capitalized expenses may be overstating EBITDA

CHGGs transition from a textbook rental company to a fully digital business should reduce
capital intensity. Historically, outside of textbook purchases, CHGG has been a relatively
capital light model, spending 2% to 3% of revenue on capital expenditures. CHGGs
education, marketplace, and consumer internet peers generally spend less than 5% of revenue
on capex as well.
However, through the first nine months of 2016 CHGGs capex has more than tripled,
increasing to over 9% of revenue. In fact, through the first three quarters alone, CHGGs
capitalized expenses are more than twice what the company spent through all of 2015. In
particular, in Q216 CHGGs capex was nearly 18% of revenue. Despite the massive increase,
________________________________________________________________________33
------------------------------------------------------------------neither Mr. Rosensweig nor Mr. Brown addressed the issue in their prepared remarks on the
Q216 earnings call. When asked during the Q&A about the abnormal increase, Mr. Brown
stated, I think when you think about CapEx for Chegg, its a little bit of a misnomer. Most
people think its buildings and things like that, but we also capitalize a lot of our content cost
and things like that.60
Mr. Browns explanation for 18% of revenue going towards capex is that CHGG has
historically capitalized its content costs. But this explanation fails to reconcile. If capitalizing
content costs was a historical practice and does not represent a change in strategy, then
capitalized content costs dont explain the disproportionate increase in capitalized expenses
relative to revenue.
We believe the actual explanation is that CHGG management has shifted operating expenses
from its income statement to capitalized expenses on its balance sheet. While this strategy
inflates adjusted EBITDA by excluding the resulting depreciation, it does not alter the overall
cash flow of the business, which, as discussed below, continues to deteriorate.
CHGG Capex Analysis
$ 000s
Revenue
Capex
Capex % of Revenue
2013
255,575
2014
304,834
2015
301,373
YTD 16
191,033
7,369
2.9%
5,083
1.7%
8,253
2.7%
17,834
9.3%
III. Management quietly pushed out its target operating model by one year
As CHGG has been pivoting from a textbook rental business to a 100% digital business,
management has repeatedly shared its target operating model. With the Ingram transition
expected to be completed by the end of 2016, management made the logical argument that its
target model would be achieved in 2017. Throughout 2015, CHGG included its target model
and timeline in every publicly filed investor presentation. As recently as November 2015, and
seen in the screenshots below, CHGG publicly endorsed achieving its target financial model
in 2017. On CHGGs Q315 earnings call, Mr. Brown again promised, During 2017 we
expect to reach our target model of 25% revenue growth, greater than 60% gross margins, and
25% EBITDA margins, along with strong free cash flow.61 That sounded pretty good.
However, when CHGG reported its Q415 earnings results just three months later, the widely
promoted target model was shifted by an entire year into 2018. In addition to shifting the
target model date from 2017 to 2018, management also quietly changed its revenue target
from 25% total Revenue Growth to 30% Chegg Services Revenue Growth. As is often
the case with this management team, there was no explanation provided for the meaningful
target model change or year-long push-out. As we discovered last week when management
________________________________________________________________________34
------------------------------------------------------------------provided initial 2017 guidance for revenue growth of only 19%, we believe the revenue
growth target change is due to the fact CHGG is materially behind its operating plan.
Source: CHGG IR presentation, 11/2/15
Source: CHGG IR presentation, 22/22/16
IV. CHGGs business model(s) perpetually destroy capital and burn cash
We think it's important for people to know that we generate a lot of cash and we are able to
generate free cash flow. And that's something that is new to Chegg One of the wonderful
things that we can say for the first time since we've been public is we generate a lot of cash
from operations. Dan Rosensweig, CHGG Q216 earnings call, 8/1/16
With all due respect to Mr. Rosensweig, we believe this quote demonstrates either a lack of
understanding about the definition of cash flow or intent to deceive investors. While CHGG
has generated cash year-to-date, the primary sources are unsustainable or the result of timing.
Specifically, cash flow from operations has been distorted by the proceeds from the
liquidation of textbooks (which will cease next year) and the timing of fall semester rush
payments that will be remitted to Ingram in Q416. More importantly, based on
managements guidance that CHGG will end the year with $50 to $60 million in cash,
CHGGs operating free cash burn will be north of $25 million in 2016, which represents a 3x
increase over 2015.
Prior to 2015, when CHGG commenced its business transition away from print textbooks, the
company actually generated significant cash flow from operations. While the operating cash
flow never translated into free cash flow because of significant cash outflows for textbook
purchases, cash flow from operations was indeed positive. However, cash flow from
operations turned negative in conjunction with the digital transition in 2015, and in a direct
contradiction to Mr. Rosensweigs statement, the negative cash flow is expected to intensify
in 2016.
While there could be possible explanations for Mr. Rosensweigs inaccurate and misleading
public cash flow statements, it is our opinion that (a) Mr. Rosensweig misrepresented the
actual economics of the business, or (b) he does not understand the definition of free cash
flow. Unfortunately for shareholders, neither is a good explanation.
________________________________________________________________________35
-------------------------------------------------------------------
CHGG Free Cash Flow Analysis

$ 000s
Cash Flow From Operations

Purchase of Computers, furniture, and equipment
Operating Free Cash Flow
2011
32,754
(4,428)
28,326
2012
54,681
(2,707)
51,974
2013
63,706
(15,148)
48,558
2014
68,475
(5,083)
63,392
2015
(82)
(8,253)
(8,335)
2016G
(2,608)
(22,500)
(25,108)
Purchase of Textbooks
(74,094) (104,518) (122,247) (112,814)
(32,297)
(795)
Proceeds from Liquidation of Textbooks
30,882
34,076
37,946
58,119
38,260
26,873
Net Textbooks (Purchase) / Proceeds
(43,212)
(70,442)
(84,301)
(54,695)
5,963
26,078
2016 cash flow based on midpoint of management guidance from Q3'16 earnings call to end year with $50 to $60 million in cash.
2016 capex based on midpoint of management guidance from Q2'16 earnings call.
Assumes $3 million proceeds from liquidation of textbooks in Q4'16.
Mr. Rosensweigs mis-statements appear consistent with a troubling trend of management

playing fast-and-loose with its free cash flow guidance. For example, in early 2015
management stated, We expect free cash flow in the range of $15 million to $25 million.
Although this is a large increase over 2014, we expect to see an accelerated benefit to cash
flow through 2016 and beyond as a result of the payment terms to Ingram and the freeing of
our capital from being tied up in new inventory. 62 Despite clearly tracking behind plan,
management reiterated this cash flow guidance on its Q115 earnings call. On its Q215
earnings call, management lowered its free cash flow guidance to $15 to $20 million. As the
year progressed, and the company continued to track behind plan, management stopped
discussing free cash flow entirely. Ultimately, CHGG generated a free cash flow loss of $8
million in 2015. Even giving the company credit for lumpy net gains from the liquidation of
textbooks, free cash flow was still negative $2 million well below managements guidance.
V. Imagine Easy earn-out payments may impair CHGGs balance sheet
CHGG was cash rich after raising $180 million in its IPO. Due to operating losses, textbook
library investments, numerous failed acquisitions, and untimely share repurchases, CHGG
will have burned through all but ~$55 million of cash by the end of 2016. And as shown
above, CHGGs digital business utilizes significant cash when capitalized investments are
included.
While $55 million of cash may seem manageable, the companys cash position appears
precarious. As seen in the table below, CHGG has $35 million of earn-out payments due to
Imagine Easy, of which $27 million represent payments expected to be made in 2017.
Combined with the expected cash burn rate exceeding $25 million, we believe CHGG will
need to access the capital markets within twelve months. [NOTE: CHGG maintains a $30
million revolving credit facility, but based on restrictive EBITDA covenants, we believe the
revolver may not be accessible.]
________________________________________________________________________36
------------------------------------------------------------------CHGG Imagine Easy Payment Requirements

$ 000s
Purchase price
Contingent consideration
Total
Q2 16
25,000
25,000
Q3 16
Q4 16
3,000
3,000
2017
17,000
7,350
24,350
2018
5,400
5,400
2019
2,250
2,250
Total
42,000
18,000
60,000
7) Rubber meets the road in 2017 & VCs and insiders are voting with their
feet
I. CHGG will struggle to meet 2017 consensus expectations
GAAP and pro forma become the same when we get to 2017, so there wont be any
difference. It will be just GAAP only. Andrew Brown, CHGG CFO, Q415 earnings call,
2/22/16
CHGG management has been 100% clear that the 2017 income statement will no longer
include arbitrary and misleading pro forma adjustments. As such, CHGGs pro forma 2016
guidance should provide a clean baseline off of which investors can bridge 2017 guidance.
Based on extensive analysis, we believe growth expectations are materially too high and
CHGG will disappoint investors throughout 2017. Management already lowered 2017
expectations when they provided initial revenue guidance approximately $5 million below
prevailing consensus estimates on the Q316 earnings call. We believe this is the first of many
negative revisions to come.
Pro forma Required Materials revenue growth has decelerated since 2013 and
managements 2016 guidance implies the segment will actually decline by nearly 9%.
CHGGs lack of product differentiation and the intense competitive environment should
prevent the segments performance trends from improving. Even management appears to
agree with this conclusion, as implied 2017 guidance assumes Required Materials decline
accelerates next year. While managements guidance implies Required Materials will decline
11.5%, based on recent trends and increasing competition, we believe Required Materials
decline worsens to 20% next year. Based on what we believe is a more realistic level of
decline, Chegg Services growth would need to re-accelerate from 28% (management
guidance for 2016) to nearly 40% to meet managements guidance. Considering Chegg
Services growth has consistently decelerated in each of the last four years, we do not believe
such a strong re-acceleration will occur. Even taking managements guidance at face value,
Chegg Services growth would need to re-accelerate to ~35% in order to achieve 2017
numbers. Finally, it is important to also keep in mind that as the Required Materials segment
disintegrates, CHGG will lose its purported low-cost customer acquisition funnel.
We are convinced that management will be forced to make more frequent (or larger)
acquisitions, or 2017 will be the year CHGGs promotional story unravels.
________________________________________________________________________37
------------------------------------------------------------------CHGG Services Growth Analysis

$ 000s
2012
Required Materials
45,900
Chegg Services
24,649
Total Revenue
70,550
2013
57,192
41,830
99,022
2014
66,111
68,117
134,228
2015
71,818
94,286
166,104
2016G
65,500
120,500
186,000
2017E
52,400
167,600
220,000
YoY Growth
Required Materials
24.6%
15.6%
8.6%
(8.8%)
(20.0%)
Chegg Services
69.7%
62.8%
38.4%
27.8%
39.1%
Total Revenue
40.4%
35.6%
23.7%
12.0%
18.3%
*2016G assumes midpoint of guidance and excludes $7 million estimate for ImagineEasy.
*2017E excludes $10 million estimate for ImagineEasy.
II. VCs and insiders heading for the exits before the next reset
CHGG raised significant venture capital during its six years as a private company. Many of
the early-stage VCs are trapped with large investment losses. Rather than continue to patiently
support CHGG through its highly anticipated digital transition, several of CHGGs most
knowledgeable investors have exited their positions. In fact, three of CHGGs top six pre-IPO
shareholders sold their entire investment. CHGGs largest pre-IPO shareholder, Ace ltd.,
exited its stake in 2015, which we believe is a particularly troubling development. Ace
benefited substantially from one of the aforementioned pre-IPO ratchet provisions its stake
increased by nearly 40% from 7.6 million shares to 10.5 million shares at CHGGs IPO and
the firm had been an investor in CHGG for less than five years. Venture firms are typically
patient, long-term investors, who support management teams through value-creating
transitions. Yet, despite its short holding period and substantial increase in ownership due to
the ratchet provision, Ace exited its entire investment before reaping the rewards from
managements promotional pivot.
CHGG Venture Capital Ownership Analysis
Ace Limited
Insight Venture Partners
Kleiner Perkins
Gabriel Ventures
MOOS LLC
Foundation Capital
Total
Pre-IPO Shares Held

10,499,998
8,677,391
8,355,135
7,410,283
5,765,690
4,670,819
45,379,316
Current Holdings
7,451,067
8,355,135
7,358,364
23,164,566
% Sold
100.0%
14.1%
0.7%
100.0%
100.0%
49.0%
In addition to many of CHGGs VCs exiting their investments (many at losses), corporate
insiders are also heading for the door. Charles Geiger, CHGGs Chief Product Officer, has
________________________________________________________________________38
------------------------------------------------------------------dumped nearly $1 million of stock since August, decreasing his ownership position by more
than 80%.
Geiger Family Trust Transactions
Date
Shares Sold
Price
Amount
8/2/2016
74,334
8/4/2016
11,543
8/5/2016
33,457
8/11/2016
25,000
Total
144,334
$6.06
$6.50
$6.53
$6.75
$6.32
$450,501
$75,030
$218,541
$168,800
$912,872
Shares Held
177,147
102,813
91,270
57,813
32,813
Why would VCs and insiders, who presumably understand CHGGs business and digital
transition better than unaffiliated holders, sell so much stock just as the company is on the
precipice of reaching its target model? We believe the answer is because VCs and insiders
know CHGG will not deliver on 2017 estimates, and managements business pivot will be
exposed as a stock promotion.
8) CHGG is significantly overvalued

I. CHGG trades at a substantial premium to education-focused peers and a broader consumer
internet basket
No matter how the story is spun by management or its sell-side cadre, CHGG is an education
technology company. The business utilizes technology to provide textbooks and other
services to college students. There are no unique moats around CHGGs business and the
company has no proprietary processes, manufacturing know-how, or intellectual property.
CHGG is no different than its education-focused peers, most notably BNED, which operates
campus bookstores and provides study guides, new, used, and digital textbooks, and other
course materials. Companies that serve college students operate in a low growth market, with
a fickle and consistently churning end-consumer, and significant competitive pressures.
Unsurprisingly, BNED and other education companies generally trade for less than 1.0x
revenues and 5x-7x EV/EBITDA.
CHGG on the other hand is covered by internet and e-commerce analysts who have been
captivated by managements pivot story. CHGG currently trades at more than 3.5x pro
forma revenue and 50x EV/EBITDA.
Even if we expand the peer group to a broader set of marketplace franchises and consumer
internet businesses, CHGG is still a significant valuation outlier. While nothing about CHGG
resembles the financial profiles, growth and cash flow characteristics, and competitive
dominance of companies like AMZN and LNKD, we generously selected a vast peer group.
________________________________________________________________________39
------------------------------------------------------------------For example, we utilized LinkedIns current valuation, which embeds Microsofts 50%
acquisition premium.
Incredibly, despite declining GAAP revenue, decelerating pro forma revenue growth, negative
free cash flow, and a structurally broken business model, CHGG trades at a substantial
premium to AMZN, LNKD, and every other consumer internet or e-commerce peer we could
imagine. While it should presumably trade at a discount to the basket below, CHGGs stock
price trades at over a 100% revenue multiple premium and over a 300% EBITDA multiple
premium.
CHGG Comparable Company Valuation Analysis
$ 000s
Enterprise
Company Name
Ticker
Value
Education-focused Peers
Barnes & Noble Inc
BKS
852,055
K12 Inc
LRN
438,441
Barnes & Noble Education Inc BNED
474,980
Scholastic Corp
SCHL
1,149,576
Houghton Mifflin Harcourt Co HMHC
1,916,614
Mean
Median
Consumer-internet and E-commerce Peers
eBay Inc
EBAY
IAC/InterActiveCorp
IAC
Groupon Inc
GRPN
LinkedIn Corp
LNKD
Angie's List Inc
ANGI
Amazon.com Inc
AMZN
Mean
Median
32,466,809
5,599,071
1,833,810
23,713,531
476,942
353,395,126
Total Mean
Total Median
2016E
Revenue
2016E EV / 2016
EBITDA
Revenue
EV / 2016
EBITDA
4,019,333
905,500
1,857,000
1,785,500
1,377,125
202,500
96,400
70,000
149,000
200,571
0.2x
0.5x
0.3x
0.6x
1.4x
0.6x
0.5x
4.2x
4.5x
6.8x
7.7x
9.6x
6.6x
6.8x
8,989,727
3,110,444
3,124,250
3,780,200
327,444
136,868,325
3,456,222
500,600
157,947
1,129,100
22,491
15,060,875
3.6x
1.8x
0.6x
6.3x
1.5x
2.6x
2.7x
2.2x
9.4x
11.2x
11.6x
21.0x
21.2x
23.5x
16.3x
16.3x
1.8x
1.4x
11.9x
9.6x
Chegg Inc
CHGG
715,935
193,000
14,000
3.7x
51.1x
Source: Bloomberg and company filings.
CHGG 2016 revenue based on midpoint of pro forma guidance. 2016 EBITDA based on midpoint of guidance less
$5 million of estimated gain on liquidation of textbooks and acquisition-related compensation.
II. Generous valuation implies 75%+ downside

While revenue multiples may provide a stop-gap valuation methodology for a company that
loses money and burns cash, ultimately mediocre businesses are valued on prospective
earnings or EBITDA. Fortunately, CHGG management has publicly directed investors
towards its positive adjusted EBITDA as a framework for valuation. For 2016,
managements most recent EBITDA guidance is $18 to $20 million. If we use $19 million as
a baseline and adjust for $5 million of one-time gains on textbook liquidations that will not
recur in 2017 and cash-based recurring acquisition-related compensation (the company
________________________________________________________________________40
------------------------------------------------------------------reported $4 million YTD for these two items), CHGG should generate approximately $14
million of recurring EBITDA this year.
While we believe CHGG should trade in-line with its education-focused peers (i.e., 5-7x
EV/EBITDA), we have assumed the promote garners a broader, more generous peer group
multiple of 11.9x. After including CHGGs estimated year-end cash balance and deducting its
Imagine Easy earn-out obligations, CHGGs intrinsic equity value is $186 million.
Finally, while CHGG reported 91 million basic and diluted shares in Q316, this share count
excludes 11.2 million anti-dilutive shares. Using CHGGs correct fully diluted share count of
102 million shares, CHGGs intrinsic per share equity value is $1.82, or 77% downside from
the current share price.
CHGG EV / EBITDA Valuation Analysis
$ 000s
CHGG 2016E EBITDA
Multiple
14,000
11.9x
Enterprise Value
Year-end Estimated Cash
Imagine Easy Earn-out Requirements
CHGG Equity Value
166,312
55,000
(35,000)
186,312
Basic Shares Outstanding

Potentially Dilutive Shares
Total Diluted Share Count
91,059
11,244
102,303
CHGG Per Share Intrinsic Value
$1.82
Current Share Price

$7.88
Downside
(76.9% )
2016 EBITDA based on midpoint of guidance of $19 million
less $5 million of estimated gain on liquidation of textbooks
and acquisition-related compensation.
________________________________________________________________________41
-------------------------------------------------------------------
http://www.wsj.com/articles/SB10001424052702304244904579278580848831864
http://www.iowastatedaily.com/news/article_4b64b1fa-08f2-531a-b714-7672985709d0.html
3
VentureSource, accessed 9/5/16
4
http://blogs.wsj.com/digits/2015/10/21/valuation-hungry-startups-should-heed-cheggs-disastrous-ipo-ratchet/
5
CHGG S-1, 10/31/13
6
http://blogs.wsj.com/digits/2015/10/21/valuation-hungry-startups-should-heed-cheggs-disastrous-ipo-ratchet/
7
Ibid
8
CHGG S-1, 10/31/13
9
CHGG S-1, 10/31/13
10
Ibid
11
BMO Capital Markets Initiation Report, 12/9/13
12
Bloomberg.
13
http://adage.com/article/news/zdnet-trudges-tech-site-rebuilds/1249/
14
Webvan raised $375 million in November, 1999 - https://en.wikipedia.org/wiki/Webvan
15
Bloomberg. ZDNets stock price declined from $36.00 on 3/31/99 to $9.00 on 6/30/00
16
http://adage.com/article/news/zdnet-trudges-tech-site-rebuilds/1249/
17
CapitalIQ.
18
http://www.bloomberg.com/news/articles/2016-07-25/what-sank-yahoo-blame-its-nice-guy-founders
19
http://www.ocala.com/news/20061207/yahoo-tackles-mess-of-its-own-with-sweeping-changes
20
Ibid
21
http://www.businessinsider.com/2008/6/was-yahoo-s-terry-semel-the-worst-internet-ceo-ever-yhoo22
http://prev.dailyherald.com/story/?id=135843
23
http://investor.activision.com/releasedetail.cfm?releaseid=372199
24
http://www.hollywoodreporter.com/news/rosensweig-plays-lead-guitar-hero-81142
25
https://www.theguardian.com/technology/2010/feb/02/guitar-hero
26
Ibid
27
http://www.wired.com/2011/02/guitar-hero-canceled/
28
http://www.nytimes.com/2009/07/05/business/05ping.html?_r=0
29
CHGG S-1
30
Ibid
31
http://www.newsobserver.com/news/business/article82494022.html
32
Ibid
33
http://fortune.com/2015/10/07/amazon-pick-up-college-campuses/
34
Ibid
35
Ibid
36
Ibid
37
https://campustechnology.com/articles/2016/09/14/pearson-follett-partner-on-digital-textbook-program.aspx
38
Ibid
39
http://investor.chegg.com/press-releases/press-release-details/2016/Chegg-Reports-Q3-2016Earnings/default.aspx
40
CHGG Q216 earnings call, 8/1/16
41
42
https://www.chegg.com/tutors/pricing/
43
44
Ibid
45
46
https://www.sec.gov/Archives/edgar/data/1364954/000000000015056977/filename1.pdf
47
Ibid
48
https://www.sec.gov/Archives/edgar/data/1364954/000136495415000195/filename1.htm
49
50
51
https://www.sec.gov/rules/final/33-8176.htm
2
________________________________________________________________________42
------------------------------------------------------------------52
http://www.debevoise.com/~/media/files/insights/publications/2016/05/20160519_non_gaap_metrics_in_the_cro
sshairs_sec_issues_new_guidance.pdf
53
https://www.sec.gov/divisions/corpfin/guidance/nongaapinterp.htm
54
https://www.sec.gov/rules/final/33-8176.htm#P154_25346
55
CHGG Q216 earnings release
56
Refer to Q315 earnings release
57
ISS Proxy Analysis
58
CHGG 2016 Proxy Statement
59
60
Ibid
61
62
________________________________________________________________________43

Chegg - A Textbook Story of Fiction

Uploaded by

Document Information

Copyright

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Chegg - A Textbook Story of Fiction

Uploaded by

Copyright:

COPPERFIELD RESEARCH

Chegg, Inc. (CHGG) A Textbook Story of Fiction

IMPORTANT Disclaimer Please read this Disclaimer in its entirety before

2) CHGGs textbook rental business is commoditized & faces increased competition

Each revenue reclassification appears to coincide with a specific quarter in which

------------------------------------------------------------------1) CHGGs inauspicious background and value-destroying CEO

Source: CHGG S-1.

------------------------------------------------------------------CHGG Shares Outstanding Analysis

Shares Shares Issued

II. Dan Rosensweigs dubious leadership track record

2) CHGGs textbook rental business is commoditized & faces increased

Comparison Rental Pricing for Campbell Biology

CHGGs inability to compete in the rental textbook market, as evidenced by managements

3) Chegg Services stability, margins, and growth characteristics are

Annual Renewal Rate

II. Chegg Tutors pricing implies management misrepresented gross margins

------------------------------------------------------------------IV. Chegg Services subscriber growth is significantly overstated

Source: Q315 CHGG earnings press release.

Source: Q316 CHGG earnings press release.

As part of CHGGs shifting segment disclosures (which we discuss in detail below), we

------------------------------------------------------------------CHGG Subscriber Analysis

Normalized Digital Subscribers

Organic Digial Subscribers

Reported Digital Subscribers

4) CHGG has consistently misrepresented its financial & segment

Rental or sale of print textbooks

Print textbooks, eTextbooks, and Ingram commission revenues

Source: Company filings.

------------------------------------------------------------------CHGG Digital Revenue Growth

Reported Digital Revenue

------------------------------------------------------------------CHGG Normalized Digital Revenue Growth

Reported Digital Revenue

Chegg Services Guidance (excluding ImagineEasy)

Source: CHGG IR Presentation, 8/4/15

Source: CHGG IR Presentation, 2/22/16

IV. The SEC requested information regarding CHGGs revenue reclassifications

Rental rental of print textbooks

EBIT - excluding gains on textbook liquidations

In addition to CHGGs abuse of non-GAAP profit adjustments, we believe management has

5) Managements egregious compensation & other conflicts of interest

YTD 16 Stock Comp

Source: CHGG Q316 10-Q.

II. Managements excessive pay is not tied to performance

Source: CHGG 2016 Proxy Statement.

Digital revenue net Ingram

Free cash flow

Source: Company filings.

Company Reported EBITDA

II. Significant increases in capitalized expenses may be overstating EBITDA

Source: CHGG IR presentation, 11/2/15

Source: CHGG IR presentation, 22/22/16

CHGG Free Cash Flow Analysis

Cash Flow From Operations

Mr. Rosensweigs mis-statements appear consistent with a troubling trend of management

------------------------------------------------------------------CHGG Imagine Easy Payment Requirements

------------------------------------------------------------------CHGG Services Growth Analysis

Pre-IPO Shares Held

8) CHGG is significantly overvalued

II. Generous valuation implies 75%+ downside

Basic Shares Outstanding

CHGG Per Share Intrinsic Value

Current Share Price

You might also like