Chegg Inc. Finds Its Niche

College students will no doubt be familiar with Chegg Inc. (NYSE: CHGG). The company's textbook-rental site saves students significant money versus purchasing books outright. In 2015, Chegg decided to alter its business model in favor of more lucrative long-term opportunities.

Below, our Motley Fool Industry Focus: Consumer podcast hosts discuss the changes and their impact on Chegg's business.

A full transcript follows the video.

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This video was recorded on Sept. 19, 2017.

Vincent Shen: Asit, the first company that we'll cover is Chegg, ticker CHGG. This is one that you brought to my attention, and they offer a ton of different services to students. Can you give us a quick overview of the company?

Asit Sharma: Sure. Chegg, or, as students know it, provides textbook rentals to students. That's primarily what they're known for. Books were expensive when I was in school years and years ago, and they've only gotten more expensive. So with the tools that we have today, students can go online and go to CampusBooks or Amazon textbook rentals and rent a book at maybe a 50% discount, 60% discount, or 90% discount to the cost of the book and return it at the end of the semester. So this is what Chegg has primarily provided to students. In the past, it used to buy its own textbooks, operate them on an inventory basis, rent them out, make money that way.

But in 2015, the company actually signed an agreement with Ingram Content, which is a huge book seller, and it now has that company fulfill its rentals, and it just takes a commission of about 20% on each textbook that it rents. So it's a more capital-light model, which is more profitable. What the company has done in the meantime is turn its attention to services. It bills itself as a "student first" platform. That means, from the time you're in high school, it helps you select colleges, it helps you with standardized test prep. When you get into college, it has neat services such as this answer module where you can pose a question to one of 35,000 experts, and they will provide an answer, and that becomes part of a great content system that other students can later review. And it provides tutoring services, which can be as low as $0.40 a minute through this vast army of online tutors. So the company is trying to position itself as a student's best friend in getting through not just high school but college and graduate school. It's a massive market, there's a lot of market opportunity here for a company like this.

Shen: Chegg management actually cites in their latest quarterly report, the education industry in total, $1 trillion industry, 7% of the U.S. GDP. The company said that in 2016, last year, they served 6.5 million students. And there are 1.2 million actual subscribers to Chegg as of the second quarter of 2017, and that number is up 54% year over year. Those 35,000 experts that you mentioned answering questions, one of the services they offer, they've gotten 10 million questions so far through that service.

But the big thing to remember for this business is the transition from the textbook rentals, and now that it's taking that 20% commission, and now that Chegg considers itself a fully digital company -- just remember that relieved the company of having to worry about things like its textbook inventory, so no more depreciation expense, no more shipping, no more fulfillment, no more warehouses, no more personnel costs for that. Here are some financial numbers for their business segments. Even though the top line has declined as a result of the agreement it's made with Ingram, it's down 16% in 2016, their gross margin for the company is improving significantly. It was about 39% in 2015, then 53% in 2016. And full year guidance from management for this current year 2017 puts gross margin at over 65%. So you can see how quickly that's ramped up as they turn to focus more on services.

Not surprisingly, their Chegg Services segment accounts for an increasing portion of revenue. Now, it makes up the majority of the top line. In the latest quarter, the second quarter of 2017, it was reported that number for Chegg Services accounts for 79% of the top line, and year over year growth there was 50%.

Asit Sharma has no position in any of the stocks mentioned. Vincent Shen has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.