Our Foolish Interview With 2U Inc CEO Chip Paucek

Formal education is changing quickly, and two-time Rule Breakersrecommendation 2U (NASDAQ: TWOU) is playing a pivotal role in what its future will look like.

2U partners with large schools to develop immersive online programs. This gives students an opportunity to obtain a graduate degree from a prestigious university but with the freedom to attend classes remotely and remain in the city where they're currently employed. Forbes described 2U in 2012 -- when it was still named "2tor" -- as one of 10 Startups Changing the World.More recently, UC-Berkeley referred to it as "arguably the most successful degree of the entire UC system."

2U is also a company that should be on the radar of Foolish investors. It has beaten Wall Street'sexpectations every quarter since going public in 2014, and several of us at The Motley Fool think it has many more good report cards still to come.

In the interview below, Motley Fool Exploreradvisor Simon Erickson chats with 2UCEO and co-founder Chip Paucek about the following topics:

  • How 2U is putting a new spin on traditional education (1:09)
  • How to choose which universities to work with (3:14)
  • How to build long-term programs and relationships (7:24)
  • The three decisions that established 2U's competitive advantage (9:57)
  • The importance of prestige to universities, students, and 2U (12:03)
  • How to replicate the networking aspect of traditional universities (15:21)
  • What should investors know about the education industry? (18:55)
  • Complete Q&A from our audience (22:40)

If you're interested in reading our two formal recommendations of 2U and a free trial to Motley FoolRule Breakers, simply click here.

A full transcript follows the video.

Simon Erickson: Welcome to Chip Paucek who is the co-founder and CEO of 2U, who is an education technology company that's partnering with leading colleges and universities to deliver some of the world's greatest online degree programs. Chip, when you first founded the company, Forbes named your group one of the "10 startups changing the world", and more recently the UC Berkeley system has praised 2U's programs as arguably the most successful online degree in the entire UC system. It is also a two time recommendation of Motley Fool Rule Breakers, and Chip has been named Ernst & Young's entrepreneur of the year and sports a 97% approval rating on Glassdoor. Chip, thanks for being at The Motley Fool this morning.

Chip Paucek: Thank you for having me! Very happy to be here! I've followed the Fool for years, because this is my third venture backed company in the D.C. area and I started my first one way back when Tom and David started The Fool, so love what you guys do.

Erickson: Now, when you founded the company it was originally 2tor, and you made the decision to change the name to 2U. It does say you're putting a different spin on the traditional education market.

Paucek: We partner with top universities to build what we believe are the world's best online degree programs, in some ways the world's best digital education. There are great institutions like Berkeley as you mentioned, or Yale or Georgetown or USC or now my soon to be alma mater UNC, and it's a very different approach to online education, so the whole idea behind 2U is to power super intimate weekly live classes with great faculty members. This is not an asynchronous online program, and you get the exact same degrees you would on campus, so there's no difference between the degree. I would argue, you can make a reasonable argument that's it a more intimate experience because the average class size across the portfolio is 12, so you're in very intimate small classes with a great Berkeley professor on a weekly basis. And so 2U powers the system behind the scene, so we're not a consumer known brand. Our job is to promote Berkeley and Yale and Georgetown, not to promote 2U. We provide a variety of technology, comprehensive service, and the data infrastructure, and the funding to launch all of the programs.

The business model behind it is we take a long-term revenue share. Our shortest contract is 10 years, and 2U will take more than half the tuition revenue for each incoming degree student. So a very different approach, and when we IPO'd three years ago, there was really nothing quite like this in the market. Wall Street as you know likes comps, likes to compare one company to another company, and there hasn't been an ed tech company that's been successful in the public markets in a very long time. I'm very proud to say that we're doing a pretty darn good job of it. We just had our 12th beat and raise last Thursday.

Erickson: You named some very large universities there, Yale, UC System, UNC, these are large universities that are already out there. Do you consider those universities as competitors, or are they partners of yours, and how do you choose which universities you want to team up with?

Paucek: Well, so hitting the first one upfront, you know, it's a little bit of both. We support the great universities that have made a decision to end the segregation of the online student, to bring the online student into the fold in a very real way. You're becoming a full member of that community. You're becoming a Trojan, a Tar Heel, a Hoya, you're not just a random master's graduate. It's a really big change for a school that's been doing this a particular way for literally hundreds of years. When we talk about the competitive landscape of higher ed, and one of the things that's pretty notable about our partner suite is companies don't last this long. Companies literally, you're talking about hundreds of years old. Chapel Hill and Georgetown were two of my first three clients. They were founded in 1789. To put that in perspective, Coca-Cola, which is probably the best brand in the world or certainly a top five brand was founded a hundred years later in 1886.

Chapel Hill and Georgetown have literally a hundred years on one of the biggest brands in the world. We take that very seriously. We are brand stewards of some of the best schools in the world, standing behind them to allow them to make this digital transformation. It's not a small thing. I think this is a huge secular change happening across higher ed. If you're in a graduate program somewhere, the question you have to ask yourself is why should you pick up your life, quit your job and move to attend if you can get everything you would get in that campus experience online instead? Even the physical component. The school's that partner with us, they're our customers, they're our partners. We compete in this very large some would say $1.5 trillion worldwide higher education. If you look at the US graduate education, which is what we specifically play in is $80 billion. Very big market.

We're choosing to partner with schools where we've identified the market opportunity and it meets institutional will. I don't say that lightly, the story of 2U in some ways is the story of institutional will more than any other single thing. You think about if you're a great school and you're ranked in the top 20, like let's say Kenan-Flagler at UNC, the fact that they agreed to do this with us is kind of crazy. There was no data to support it. You know, Hi, Mr. President! I'd like you to take a bunch of online students you never had before and I'd like you to give them the exact same degree and don't worry, the alums won't freak out, and I promise we can find good ones and I promise we can build great technology, and I promise we can support them, and by the way, I'd like more than half your tuition please.

It was a crazy idea in 2008, but fortunately a couple of great leaders believed, they sort of didn't let the skeptic win, that's one of our guiding principles, and they actually went for it, and here we are today and we just passed $1.5 billion in tuition generated for the partners that are in our suite.

So a long way of saying it is a combination. We do compete in this broader ecosystem of higher education. With that said, I feel like where we are is where Tesla is with electric cars. The reality is more electric cars are better for Tesla, whether Tesla's making them or not, and my biggest issue as CEO of the company is preconceived notions of online education. They're terrible. If any of you in the audience are thinking about getting a degree, your first instinct today is not to get an online degree because historically the online programs were not that great. So that's a big part of our story is changing those notions over time, and we do think it leads to an extremely large market opportunity for 2U as a company. It's pretty rare to have this kind of organic growth potential in our core market. We just do what we do well, apply more capital, and we've got a pretty decent sized moat around the company at this point, I'm happy to talk about that. That was a long answer by the way.

Erickson: Well, you said the average class size was only 12 I believe, right, and no back row so it's still kind of personal attention -

Paucek: No back row, that's our hashtag by the way.

Erickson: #nobackrow. But that's an investment for the universities as well going forward, right? They team up with 2U, they have to hire more faculty, more grading, more resources required for these, right.

Paucek: That's right. They do have to scale up the faculty. You are doing a weekly live class across the entire portfolio, and I would argue that that was a key business strategy decision in 2008 that if we had made the wrong one, there was no way I'd be sitting here with you today. You know, and the story of the founding of every company, there's key decisions when you look back and they're obvious in hindsight, but at that point it wasn't obvious. I believe it was really hard to do, because you're talking about infrastructure, you're not just talking about tech. So, you know, these live classes, they have to go off. If somebody's going to pay a $100,000 for an online degree, it better work, right? Ultimately, that decision was, I think, a very key decision, and it builds the kind of intimacy that you just don't typically see in the online environment.

I mentioned earlier that I will graduate from our MBA program in April, and I can tell you all about my classmates. I know them personally. One of my favorites is a guy named Cory Broussard who's a Shell oil engineer and he's stationed in the middle of the Gulf of Mexico for six weeks out of every quarter and he got his MBA while on a rig in the middle of the Gulf of Mexico. That's not as unusual as you would think across the portfolio. The people are truly unleashing the university from its physical boundaries.

Now, the reality is the school does have to scale up faculty, but we're doing so many things behind the scenes that even though we are taking more than half the tuition, ultimately the whole notion behind a 2U contract is a long term share of surplus between the parties. We build really high quality value totally based on student outcomes. The story of 2U is about driving high quality student outcomes across this portfolio. If we do that we sort of win, but the business model behind it, both sides have to win. The university has to win as well. This isn't just about 2U delivering its quarterly numbers. This is about this sort of long term secular change. The reality is sustainability is not optional. The school has to do well, and so they do have to staff up the faculty, but I would argue that's their one primary, really big expense. As an example, we do fund the programs up front, so every program we launch we're funding to get them off the ground and really up and running.

Erickson: You mentioned competitive moat which has definitely peaked the interest of investors who is our audience here today. When we were chatting earlier this morning, you had said there were three decisions to your strategy at 2U that were spot on. That were great decisions that you made. You just mentioned one of them. Can you walk through the strategies?

Paucek: The first was live classes. No back row. The seats closest to the exits are a refuge for minds that wander. Home of the unraised hand. What if you could eliminate that back row and bring every student forward?! That's our marketing copy.

Erickson: That was pretty good!

Paucek: Thank you. I actually do believe it's really relevant. You are becoming front and center with the students, the faculty. You're right there. Some days you want a back row. It's super intense to be in 2U program and that's the power of what this is. If you're a great brand and you're going online, that most important thing is quality. If you've been around for 200 years it'd better be great, right?

The second decision from a business strategy standpoint was the data infrastructure underneath the system. In 2009/2010, our early years, myself and our founding CFO really realized that we didn't have the data architecture to really do this extremely well and we brought in a whole team of people. I can tell you today I do believe that that's now world class.

The third decision was in the very early years. We only partnered with one school per discipline and that was the wrong decision. We just didn't know it at the time. So a very complicated period of history. I had to go back to all of the original schools and sort of unlock those contracts from their exclusive nature. It's very hard because we sold them in the early days on this sort of monogamous relationship. You fast forward long term and I do believe that that has made the portfolio much stronger. Believe it or not, the second school and the first school, not just the second school. That's a business strategy decision that I think if we hadn't done I'm probably not here with you today.

Erickson: I wanted to talk a little bit about prestige. You had mentioned some of this institutions that have been around for hundreds of years, and the names of those universities really helps get a lot of students enrolled which brings in tuition, brings alumni dollars in, brings in a lot of the profits that makes universities, traditional universities at least, what they are. How is prestige viewed by 2U? How it is also viewed by the universities you're partnering with, and then also the students that are enrolled in your programs?

Paucek: It's critical. It's a big part of the story. The reality is when you talk about the power of these brands, first of all I feel like when people use the word brand, they too often immediately think marketing, and I really believe that word is about relationships more than anything else. The best brands in the world have a fantastic relationship with their customer, and higher ed is no different.

In the case of higher ed, we just announced Pepperdine University a couple of weeks ago. Before we signed Pepperdine, one of standard lines that I would use to explain this is up and to that point we had 15 different universities on our system and our youngest at that point was Southern Methodist University in Texas. Great institution. It's 12 years older than Walt Disney. That was our youngest. 12 years older than Walt Disney. Companies don't last this long. It really is all about that power of that brand, and in that brand is built in an incredible network of people doing amazing things.

When people talk about the notion that all of higher ed is going to go away because of a massive open online course, I feel like those folks lack the understanding of what's actually happening in those systems. People form a permanent relationship with these institutions. It is permanent. It is intense, it is personal, and so of course the prestige of that relationship is really critical. Across the 2U system we don't make any admissions decisions, even though it is our job to recruit the student for the school. Our job really, and the reason it's so data driven, is to find the right student not just any student. The school makes the decision. The school brings in the students, and from that point on they become a permanent member of that community.

I would argue that the notion of prestige is huge. Now, we've chosen to sort of play at the top of the market purposefully. We think it's a great place to sort of build our competitive position, but I really think in some ways these institutions like the notion of quality is why they get up in the morning. You don't get to Berkeley at the School of Information in the data science program and become faculty unless you're pretty exceptional. What we're trying to do is get them to transition and people often will ridicule schools. They're so slow to change.

Well, if you've been around for 200 years and you've been doing something really well for a really long time, I would argue to you it's not about a fear of change it's about a fear of loss. It's about this fear of identity loss. You've done this really well a particular way, and what we find is when we get them on board and it takes time, but as you work them and you unlock the power of these brilliant faculty minds, it's pretty incredible what happens. USC Social Work, one of our programs, is producing 5% of the United States' social workers. These programs are getting large and their doing it at a quality level. This is digital education at the highest quality at scale.

Erickson: You said that you knew all of your classmates in the MBA you just completed last night.

Paucek: Thank God.

Erickson: Which, thank goodness, you're here with us this morning, too.

Paucek: I still can't believe it honestly.

Erickson: I'm impressed. How do you replicate the networking of universities in the traditional sense?

Paucek: Funny story about Chapel Hill. When we launched Chapel Hill, when I talk about our partner relationships, these are 10-year plus contracts. So our shortest contract is 10 years. The school is really locked in. That's the way it's designed, in part because we are investing $10 million of net negative cash over the first four years. It's a long term journey for 2U. When they do that, ultimately all of the programs, while it's a partnership, we're the subservient partner. It's their program. It's their degree. It's their alumni. It's their program.

So Chapel Hill in the early years said, "You know what, we want do these things called immersions." We were like, "That's a bad idea. You're taking away the one thing we're selling which is that you could do this from anywhere." They insisted and they won. What's been fascinating is they've been so popular that the school had to increase the number that they would allow for credit. This last December, they do one every quarter, the one in March is in South Africa. They move globally. The fourth quarter is always in Chapel Hill, and this past one was so large in Chapel Hill they had to do it on floor of the Dean Dome. That's when you really win the school when these 800 online students are all dressed in their Carolina blue and they're on that floor and they're there for a reason. That passion that we've captured, I'm very proud of that.

When you talk about the reasons people enroll in a program, it's not just the advancement. It's not just the fact that they want to get that job and they do and the job placement rates are great. In the case of Georgetown nursing, board pass rates high nineties. There key outcome measures. They also want that affiliation. That is what it's about. You're joining an incredible institution so you want that affiliation. The combination of live and these physical immersions really makes a difference.

One of little data point is that not in the MBA programs, but in a program like USC Social Work or Georgetown Nursing, you're actually doing a local, physical, clinical placement that 2U arranges. Part of our special sauce. We have over 100 FTEs that do nothing but clinical placement. They're finding a local place for you to go in the midwifery program and assist in the delivery of the babies. So across the portfolio over 5,000 babies have been delivered through the 2U system.

You don't want to go to the midwife that delivered the virtual baby, right? You need to do that in person, so you combine all of that together and it's a very different form of online education, but one that, I think, will have a really profound impact on all of higher ed. This is a big story, and I've been doing it nine years, but in some ways it's still early days. We're in this transition.

You're going to see, in my opinion, the $80 billion of graduate education that happens in the US, people ask me what percentage is online? That's an irrelevant question. It will all go online, I believe, over time for graduate. Undergraduate totally different story, but for graduate education, why pick up your life, quit your job and move to get a job?

Erickson: One more question for you Chip and then I want to give everyone else a chance to ask as well. I think education is starting to get some attention. You said that you had gone to CES this year. There was a track that was focused on education. I know it has brought up quite a bit in South by Southwest. Is there anything that you would like the media or investors to know about this space that maybe we're not catching onto yet or that we don't know about as well, but from everything you've seen in the past decade or so? What's something we should be keeping an eye on in education?

Paucek: I get a little frustrated when people give ed tech a hard time because this past year more went into Snapchat series E than all of that tech. So when people talk about this ... It's such a large sector of our GDP. When you look at the percentage of spend on education, if you compare that to the venture capital invested, it's actually pretty tiny. Now granted, there have not been a lot of very high profile public wins. We need more of those. Why? Because education is so critical. We need more of it not less. On some level the last five to 10 years, the demise of the for-profit space, has been bad for everybody. We need more education, not less.

What I will tell you is there are some really cool companies that are coming that I think you will see go public over the next several years. I think ed tech is getting real interesting. I'm proud that we've been able to deliver a successful path here. As I mentioned, it's early days. I feel like by definition most of venture capital investments fail. I'm a three time CEO and 2U is really the only one that I've done that's worked. I'm not shy about talking about it. It taught me a ton. If I could put my 46 year old into my 26 year old body, I would talk about focus.

I pivoted so much I was like Wilt Chamberlain back in my first company. The reality is the power of focus is something that all of the great entrepreneurs really share. Elon Musk can build the Hyperloop. He built PayPal. Sergey Brin can do the self-driving car. Look at Google. We're not there yet and we're going to stay really focused on our core market, but it makes me cherish what it is and that I know it's not about me. It's about this collective team, right team, right time, got a little lucky. The fact that USC, Georgetown, and Chapel Hill said yes. They shouldn't have. But we delivered then. Today we've got this opportunity to run this for a really long time. I intend to be around for a very long time. It's a big story we're building.

Erickson: Second inning? First inning? Second inning?

Paucek: You know, it's funny. I titled the day ... It's funny you say that. I love that question. I've never gotten that before. I titled the e-mail announcing the IPO as the second inning. I feel like it is that early. The IPO, it certainly didn't disappoint in terms of the intensity of the process. I know you and I talked about that a little bit ago. It's something that as an entrepreneur you certainly dream of. It was super intense. It was never an exit for us. It's a natural transition to a different capital source. That's really what it is. We've now proven that because we're still here, and three years in, 12 beaten raises. We think we're going to be here for a long time.

I can tell you for the local Fool community here is that we just opened our headquarters and just opened last week. It's 300,000 square feet and the 2U logo up at the top. When that lit up, if I talk about it too long I'll start tearing up. That was a real moment for me. We don't often sit back and look at it. I was staring at it, and if I go on too long here my team will laugh at me for crying in front of all of you.

Erickson: He's got some good photos of it as well. Questions for Chip?

Audience 1: You just mentioned your IPO and three years in and stuff like that. How do you balance the long term of going through a degree for the students where an MBA is a three-year program or something versus Wall Street's quarter, by quarter, by quarter?

Paucek: The first thing I think is conceptual, which is, I do believe it's a bit of a copout when people complain about the quarters. Clearly you have to pay attention to it. It's part of the process, but it has not made us short term focused. It really hasn't. When Mark Zuckerberg and Marc Benioff started talking about how it's really good to be public, then I started looking a little bit more sane. When we first IPO'd I was telling fellow entrepreneurs at tech founder conferences, "It's been great." And they look at me sideways because we were in this moment of ever expanding private capital. That's over. People are sort of adjusting to it, but I do believe it's made us a better company. Our bones are better. Our DNA is better.

That's the first answer. The second I would say we do have the benefit of an extremely predictable business model. I will give you a number that is sort of underneath the power of the system itself. When we recruit students, on average it takes about seven months for them to enroll and then they take their credits, as you mentioned, for an MBA or social work program it could be two to three years. As they take their credits, as long as we retain them we do really well.

One of the reasons I love your notion of -- David at CES asked me about it -- your social capitalism. The notion of we do well by doing good. I really believe that. It also produces a great business. Right now, backlog in our system, no new students come in the door and we just teach out and we retain our historical percentage, and we have $248 million of backlog. Thank you Ed. That's our investor relations, Ed. $248 million of backlog. That's tuition that'll come to 2U. The vast majority will go to the bottom line. It does make for a very predictable model which certainly helps us in the public markets.

Audience 2: Thanks. I got an MBA quite a long time ago, and I think the divorce rate for the married couples in our class was about 50%. You kind of mentioned about picking up and going somewhere new, and the person that's there is studying all the time. They just want to stay home and relax when they get a moment to chill. The person that moved with them just wants to go out and do things. I wondered if you had any data on the married couples that go through your programs? Maybe yourself?

Paucek: The funniest thing is we've actually had some marriages which is really crazy. We've had people in programs meet in programs and get married, which I think actually says a ton about how much you actually get to know these people. It is intense. There's no doubt. Right now across our portfolio 83% of students are either graduated or still enrolled, and the reason I'm so proud of that number is ultimately that is more akin to a campus program than it is to an online program. You typically find online percentages very low.

I don't think I could give you an accurate KPI for divorce metric of any kind. I can tell you mine made it. Fortunately we've been together 26 years. We just had our 20th wedding anniversary so she's seen it all, but this four and a half year journey for me, I didn't expect it to take four and a half years. I was definitely on the slow path, but I could only take one class a term per my board. One of the great things about the flexibility of the environment is I took classes in Dublin, Hong Kong, South Africa. I took classes all over the world. You really can make it work if you're focused on it.

I didn't do it to talk about it, I actually historically have not this a ton because first of all I was super stressed I wasn't going to make it because it's hard. Second of all, the reality is I didn't do it for the hair club or to eat my own dog food. I did it for me. I was a liberal arts major and never had a single business course and I started a company right out of college. I really wanted it. Also, Chapel Hill was an aspirational school for growing up in the South. I just wanted it. I can't believe I'm actually done. This is weird timing because I finished last night. It's an amazing experience. I can't say enough about the quality of these institutions. They're great.

Erickson: We're going to keep our eyes open for a future partnership with Match.com where you get an MBA and find your spouse at the same time online.

Audience 3: What did you learn from this experience that you were able to funnel back into your company from a UX standpoint or whether it's relating with the school's standpoint?

Paucek: You know what's fascinating about that is in the very beginning, so we weren't public yet, I decided I was going to have two sets of notes. I was going to have my school notes and I was going to have my 2U notes. It got overwhelming. First of all, I loved it enough that I not sweating as much of the small stuff, and second of all when I was taking econ or finance, I had to be all in. It was really hard. These are hard classes. I stopped taking the "2U notes", but I will tell you from a broad user experience standpoint there definitely were some lessons learned that I passed to our CTO or head of post enrollment.

The course content was shockingly useful. A couple of neat things. Not even just in the business courses, but one of the things 2U offers is as a benefit of being in the portfolio, you can take cross program courses. I took a WashU law course and I took a GW public health course, just as an example. The Wash U law course super relevant to what I'm dealing with as a public company. The thing about accounting was probably what I was most terrified about, and I don't want to scare public investors. I'm a three time CEO, but I'm not an accountant. I've read balance sheets for years, but I never made one. Going through the process making one, did that actually teach me something? Without question.

Then, there were some classes where I could teach it. The innovation courses -- what's funny about the innovation courses was they had me as a guest lecturer before I enrolled so that was a little bit weird. Then the IPO changed the experience a lit bit for me because we became public. We became a known thing. That changed it a little bit. I had to take that term off because I couldn't do it on the road show, but it's been an incredible experience. The people in these programs, the faculty in the programs, they're really exceptional. These are great institutions.

I think from a disruptive innovation standpoint, I do think that 2U is a bit like if Spotify worked with the labels way back in the original era of digital music. We are helping the schools. I happen to think that the ones ... if the 1800s was about Cambridge and Oxford, and the 1900s was the US Ivy League, the schools that do this this way are going to win in this century. It's really clear. They're not asleep anymore. These schools are waking up, so our adoption rate is picking up. You look at Kenan-Flagler. Kenan-Flagler has over 1000 high quality students in their online MBA program and they have 400 on campus. It's a huge initiative for Kenan-Flagler.

Audience 4: Tech and HR and culture issues are in the headlines lately, for better for worse, Uber. As you scaled your staff, what are some of the biggest challenges you faced, and how did you overcome them?

Paucek: So I had an opportunity to do a one on one with Reed Hastings and my single most important, because we share a board member so I felt very blessed I did a one on one with him. My first question, how much time do you spend on culture? What I feel like is interesting about 2U is there are not many people that have been on this kind of journey, and I don't mean that like I'm all great. I know at this point what I am and what I'm not.

I know it's not about me, but the journey of going from no employees to today 1,200 or going through an IPO and expecting to run it for another 10 years, there's not a ton of people that have done that journey. I actually really think 50% of my job is making sure that the culture not only thrives but gets better over time. I don't see why that shouldn't be the goal. I was very pleased by his answer because I was worried how much time I was spending on it and he sort of supported the notion. I think great culture in a company, you can over process yourself. You can process yourself to death.

Great culture in some ways -- my kids are older now, but when they were little and we took them to bowling alley, you push a button and the bumpers come up and they don't get gutter balls -- so, great culture in a company, you may not always get strikes, but it will really prevent gutter balls. I do believe that this is a key to our success. If you look at the story, great tech, great service, data architecture with this incredibly important layer of culture where people understand that they need to make service their mission. They need to be bold and fearless. Don't do it the way we did it before because I made up how to do it. Do it better. I think that's a huge part of the journey.

When I go out on the road, I'm heading to an investor conference later today, it's something that investors, I think, don't spend nearly enough time talking about. One of the reasons I love the full coverage is not that I want to hear about my Glassdoor rating.

Erickson: Sorry, Chip!

Paucek: It's okay. I get it. I also feel like it's such a critical part of building a great company, the organization, the people behind it. It's a key focus for me and I'm thrilled to be able to finally deliver a facility here that is sort of worthy of the employees. What's crazy is until two weeks ago I sat at the same desk that I've sat in for nine years. If you went from your start up office to a three hundred thousand square foot, it's kind of nuts, but that's exactly what happened. I think culture is critical to the long term health of the company.

Audience 5: Chip, one thing that I have sometimes thought about your company is that youre, in a little bit of a way like Zillow to draw an interesting comparison, in that you are an online leader in an established industry. Part of our culture. You have the potential to disrupt that. You have also partnered with the industry itself. If and when there's ever a world where we're not paying 6% to sell our house through real estate agents, we might just want to list it over Zillow. We might want to go direct with them. Until that day comes, they've made working with realtors the heart of their business. You described earlier the idea that graduate school will go all online in time. The economics would completely flip. That's really fascinating. In the meantime, you're benefiting by truly creating a win-win with the powers that be. Could you describe for me a world in which we do go all online and what that means for the institutions? Are they still able to, with the bricks and mortar, and costs and all those things, support that? What does it look like in the year 2040?

Paucek: It's always dangerous to predict that far out, but I do think you can see it happening today where what's happening is the line is completely blurring between the two. One disclaimer is at the graduate level I'm talking about, not undergraduate. I believe the power the inherent brands, the network of people involved is so critical that I'm not suggesting that It'll be done by somebody that is not a great institution. The reality is if you look at the sort of spectrum of needs, tech has always been way on the side of certification. Always. Look at Microsoft certification. You need to know that they know Ruby on Rails. If you ask the people hiring for tech, there's no question they'd rather have you know Ruby on Rails and have went to Berkeley. If you go along the spectrum all the way to the other side, the moment you have something that's a problem in your body ... You know, you've got a problem in your colon. My God, you care deeply about where you doctor went to school. So I do believe that the power of brands across the board win.

With that said, I do think in graduate education you will see more and more of it go online. I think it won't take until 2040 where you've got the majority of actual graduate degree bearing programs online, much less certification which we think is relevant to 2U long term, also. We're sort of hanging our hat on No. 1, the power of these great institutions. The power of the degree. This is not about 2U. This is not a 2U degree. It is a Carolina degree. It is a Northwestern degree. So I think that's a pretty good place to bet given they've been around a hell of a lot longer than we have.

There's no question. This is a big, big, big secular change that is occurring in the space. What's interesting is even a change in our partner suite, they're getting more aggressive talking about it. The leaders of the schools are willing to stand up and say today, not 10 years from now, I am building something. I love that you brought up the Berkeley report. It was Berkeley talking to Berkeley. It was a Berkeley report designed for the Berkeley Faculty Senate. The dean wrote a report and there's nothing marketing about it. It wasn't flashy, purely internal, but she released it to the world. A lot of comments in that made us deeply proud because she is willing to stand up and say This is one of the best things that I've done as a leader at this school.

I guess I would argue to you that long term we do think it makes for a very big market opportunity for us, but there's a much bigger thing at play here which is that the world needs more of this, not less. I'm not going to have 50% market share. Just to give you some numbers, the reality is if we just do what we do now, and we apply it to the disciplines that are super obvious and in front of us. I'm not talking about TAM. I'm talking about the immediate addressable market right in front of us. I build the number of programs that I think I can build in this current model, and they get to the current size. You know we're at a more than $3 billion top line. We think this is a really big opportunity for 2U.

Audience 5: Just to follow up on one point. Do you think that the economics of the institutions themselves, which are bricks and mortar, and those brands are built partly on the beauty of those campuses and the history of them. Do you think their own economics are going to be able to transition online only, not be disrupted, and be able to be the great brands and have the support for the online program.

Paucek: A fascinating story for you is the reason that we're so focused on graduate education is our biggest failure in nine years. When I sit here and lecture everyone on the power of focus, the one moment over the nine years where I actually tried a different model was in undergrad and I shut it down the day after the IPO. I literally rang the bell at the NASDAQ on a Friday, and on the Monday after I shut it down. It was called semester online. Big idea. It was 10 elite schools offering online undergraduate programs in our model, live classes for credit.

Everybody told us it would fail. They were right, but totally for the wrong reasons. People said this pedagogy wouldn't work for undergrads. Totally wrong, they loved it. They said the faculty wouldn't like it. Totally wrong, the loved it. It was a fascinating story about what's actually going on in terms of the value proposition of an undergraduate degree. It didn't get this sort of market interest that we expected and it was Duke, Northwestern, Wash U, Trinity College Dublin, University of Melbourne, BC, Notre Dame. Great schools.

We do think the undergraduate experience will continue to thrive, particularly at the elite level in a physical manner. We do think over time that there will be opportunities for companies like us to participate with digital products because, as an example, the undergrad students on campus loved it, but the business model was challenged. This is pre-IPO. This has not been part of our public story. I'm happy to talk about it because I do think it is super relevant to what you experience when you attend the school you attended.

I went to GW. It's hard to overstate what impact it had on my life. I met my wife there, we're still married. 26 years later we're together. It opened my world to my world. I had never seen snow. Just incredible stories about what it did for me as a human. The power of that experience I don't think is going away. How it gets augmented over time, and that blurring of the line, that's yet to be written. We think that long term that's relevant to us. Really, in the foreseeable future, we can really drive huge growth just delivering really high quality graduate programs.

We're going to do a bunch of programs no one thinks you can do online. That's the other part of the story. We just launched speech pathology with NYU. That is the third fastest in application starts for 2U in its history. You're going to see us do all kinds of programs where there's a physical thing. We're getting really good at that. The programs that none of the people in the space want to touch. We think that's a real great green field opportunity for the company to build a moat around itself. Undergrad a big part of the story long term, but for us graduate education is where we see the biggest value for 2U.

Audience 6: With a trillion dollars in student debt, and kind of a growing divide in our country between the shrinking middle class and the very wealthy folks, education is one of the few areas that the costs have grown far outpaced inflation. What role does technology play in making education at some of these great universities affordable to people that can't get it right now.

Paucek: It's a huge problem. When you talk about access, people don't typically hang 2U's hat on the access notion because we are offering No. 1 elite programs, and it is the full tuition you would see on campus. First thing to say is the single biggest cost to graduate education is the opportunity cost. The vast majority of people in our programs are staying employed while they're getting their degree and they're not paying for that whole part of picking up your life, quitting your job, and moving. It's the opportunity cost and the move. That does actually have a pretty significant impact to their debt burden.

One of the other things that's interesting about high quality online programs is if you're just throwing up your shingle and you're going online and you'd like to make it fully asynchronous, you could do something a lot less expensive, but the question is what quality would you get. For 2U, we are kind obsessed with the student outcome side. It's all about driving that high quality outcome and fortunately when people go to get their data science degree at Berkeley, they typically have a really, really high quality outcome or an advanced practice nursing degree at Georgetown or at Simmons.

You look at the outcomes metrics. There's a reason that we've been very careful to not launch masters of criminal justice programs. We're being very careful with our program selection. It makes me realize I didn't answer question earlier about we how pick them. We have an algorithm that helps us select programs. We have an algorithm that helps us predict enrollment for every program. I'm happy to explain that. I do think that 2U is relevant to our partner's long term in terms of preventing the cost to continue to increase the way it has been. We're just getting to the point now where we just had our first adjusted EBITDA positive year last year.

As I mentioned, we're still early in the journey and I wouldn't want to trivialize the investment. It takes us until year four, year five to really get to that super positive state with each program. It's a big investment, but I do think overtime one of the reasons I'm optimistic about ed tech is that there are a lot of interesting companies that are on their way.

A great example of a company that's really focused on the coding community is Pluralsight. Love this company. Fascinating company. If you don't know it you will soon. It is a great company. It's like Netflix for coding with a layer of human support on top of it. Great interesting company. In that market, that is serving my developers that are in Chelsea Piers in New York City. That's a really critical value for the world, and I think as you see more investment going to ed tech, you'll see more interesting opportunities for people to sort of further themselves. We like to say we help people reach their full potential. No back row is not just about the live interface. It's about you jumping out of the back row.

I think there will be places where you'll see skills attainment not just getting a degree, but as I mentioned I think you'll see us transition into degrees that people don't expect us to do. I do believe long term we'll do an MD. No doubt in my mind. It'll take time. It'll get a bunch of criticism because there's no question that it'll be sensitive from an accreditation standpoint, but I happen to believe that long term we will be able to do that as well or better than a campus program.

Audience 7: When you look across your portfolio today, what are some of the characteristics that separate the best programs as far as top outcomes compared to the programs that have maybe closer to average outcomes?

Paucek: What's interesting about the portfolio is the first thing you have to look at is the diversity of subject matter. Nursing has inherently lower retention on campus than an MBA program having nothing to do with 2U, having nothing to do with online. One of the reasons I'm really proud of that blended 83% rate, that's across the entire portfolio. If we were just doing business programs, it would be in the mid-nineties. The business program retention is very high. The data science program retention is very high, but the world needs social workers.

What's interesting about the school of social work at University of Southern California which was our second partner, is they have a military concentration. You're talking about former soldiers coming back from the war with PTSD. You're talking about a huge need. Across the portfolio, you do get differences. There's no such thing as a board pass rate for a Berkeley data science or for a Syracuse data science program because there is no board.

We dig deep into each vertical to try to figure out what the most important outcomes metrics are and then we care pretty deeply about our own NPS which I think is also interesting because a net promoter score is not something you typically hear a university doing. Even the notion of gradually getting our university partners to be aware of the importance of that consumer satisfaction level, and we measure faculty, student, we measure each part of our process to make sure that our application, support, and our student support, and our placement support are all strong.

The reality is, it's early days on outcomes measures. We just hired a VP of Impact. Really you can argue that their entire job is focused on not just driving the outcomes internally, but being able to report them from a research standpoint externally because we think it's really critical to the long term story of 2U.

Erickson: Let's go with one more question.

Audience 8: A little bit along those lines, I'm curious about the demographics. If you guys are finding that you're reaching maybe some segments of the population that are interesting, whether male, female, or reaching people with disabilities that maybe couldn't get to campus. I'm guessing there's some interesting stories there.

Paucek: No doubt. Somewhere in the low sixties total percentage of our student population is female. So No. 1, you've got a really interesting story right there. If you look at our American University MBA program, shockingly diverse which they're super proud of because MBA programs have a real problem there. The lack of diversity in MBA programs. You are able to tap into markets where you are not just taking share, but you're making market. The question of somebody like me. I'm not as much of a unicorn as you would think, in the MBA program. There are people like me that would not be able to do this. There is no way I'm quitting this job to do it.

There are people like that all across the portfolio for a very short time period, by the way. My wife was enrolled and she graduate two years ago in USC Education Program. I was enrolled in the UNC MBA program. For a short time period my house was 2U factory. Her classmates, it's pretty fascinating to look at the combination of geographic diversity, and the average age does go up. You're average age overall is higher than the campus. Probably four or five years. If you think about an MBA program being in the 27, 28 range, you've got to age it up. I aged it up further being 46. The average age across the portfolio is in the low 30s. This is all about giving people an opportunity to further their education that simply weren't able to do it before. That makes me pretty proud to get up and lead the company everyday.

Audience 8: My wife beat me out too.

Erickson: Chip Paucek is the co-founder and CEO of 2U. Thank you chip for joining us at The Motley Fool this morning.

Audience 8: Thank you for having me.

Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fools board of directors. LinkedIn is owned by Microsoft. Simon Erickson owns shares of Tesla and Walt Disney. The Motley Fool owns shares of and recommends PayPal Holdings, Tesla, Walt Disney, Zillow Group (A shares), and Zillow Group (C shares). The Motley Fool recommends 2U. The Motley Fool has a disclosure policy.