Citron's 2U (TWOU) Attack and Credit Suisse's Defense

Citron Research published a short report on 2U Inc. (NASDAQ: TWOU) Monday, blasting its business model, market opportunity and partnerships. It went on to suggest that the company could never attain its margin goals, that management deliberately over-marketed the stock by using buzzwords that do not match the business model then used the high valuation as an opportunity to unload their stock. No wonder the stock lost 18% of its value in the course of the day. A quick summary of the points brought up by Citron along with one brave analyst defending the company follows:

-Street belief: TWOU is a software as a service company. Citron belief: the lack of portability of TWOU’s customized solutions make it more like a for profit educational institution. The cost of each program requires a $5-10 million capital outlay that will prevent the dramatic growth seen at SAAS companies while keeping substantial pressure on margins.

-Street belief: The market is huge. Citron belief: The company focuses on Tier 1 institutions, a niche. The student body within this niche is likely to fight the adoption of online programs that could be perceived as watering down the value of their hard earned, expensive degrees. On top of this, Citron believes there are many competitors including in house developed solutions.

-Street belief: profitability will expand dramatically on existing contracts. Citron belief: Universities are going to unload risky programs onto 2U making the model fall apart over time. As evidence, it points to 85% of revenue comes from 4 programs even after being in business for nearly 8 years, NPV of an average contract at $8 million, a capital outlay of $5-10 million and a business model that absorbs the risk of the program’s success.

-Street belief: The Yale partnership is a big deal. Citron belief: Enrollments will only increase by 150 people, max benefit to the company is $5 million if successful and over several years.

Credit Suisse’s Mike Nemeroff stepped up to the plate this morning and offered his bullish view claiming Citron’s report is a hit piece deliberately drawing parallels to an industry that is under governmental scrutiny for fraud and aggressive marketing.

-CSFB belief: The university controls the admission process so only qualified applicants will participate in the program keeping the reputation of the institute and programs intact.

-CSFB belief: The graduates of TWOU’s programs receive distinct benefits from the program (implying higher salaries, increased employment opportunities etc). This is seen by the retention rate of TWOU students at 83%, comparable with the school’s traditional retention rates.

CSFB believes that since the industry is at its early stages and demonstrated success will allow the company to gain operating leverage over time.

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