2U / edX Facing Additional Existential Changes

The departure of 2U's long-time CEO was but one step in dealing with the financial crisis

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In a premium post last week after 2U / edX’s longtime CEO and co-founder Chip Paucek stepped down from his role and resigned from the board, I described that 2U was facing a financial crisis that led to the change, and that the ending of USC partnerships was a secondary issue at best. Further, I argued that the financial problem was not one of operations per se - keeping and gaining clients, profits and losses - but rather a crisis of the balance sheet - cash, debt, liabilities.

There’s more analysis to be done, but for now I will point out that 2U is replacing its chief executive officer (CEO) with its previous chief financial officer (CFO), Paul Lalljie. He is not an interim CEO, he is the new CEO. This is telling in that the board chose the financial guy as they are primarily facing a financial crisis, not an operational one. [snip]

The question that is naturally raised by this move (at least for me) is whether 2U’s board would like to exit the business. Put it on the market for acquisition in whole or in part. Take advantage of the new CEO’s skills to clean up finances and let someone else take it forward strategically. I do not have any evidence of this being the case, but I will say that this is one of the possibilities to keep in mind given the changes last week.

Now that I’ve looked deeper, I probably understated the depth of the coming changes to 2U. The company has almost no chance of generating the cash through normal business operations to pay its debts, and its debt holders are in control now. A structured bankruptcy is likely in 2024 unless these debt holders make enormous concessions. Put another way, there is almost no way that 2U / edX survives the next year without major changes, either in its offerings or in its solvency.


I should remind readers that this is not a financial newsletter. I tend to only cover corporate finances and stock prices when the topic impacts how EdTech providers operate. How they serve educational institutions and students. Well, the current 2U story is a perfect example of finances impacting real operations, and I have been remiss in not looking deeper on the financial side this year.

Further, there were three readers last week that directly or indirectly pushed me to go deeper into 2U’s balance sheet and what that means for the company’s prospects at surviving as is.

The Argument

The basic issue at hand is that 2U holds nearly $1 billion of debt with a significant portion ($380 million minimum) that must be paid off in early 2025, and the company does not have the cash or ability to generate profits to be able to cover the debt maturity. 2U had roughly $41 million in cash & equivalents as of September 30th, and it generated roughly $32 million in cash (adjusted unlevered free cash flow) in the past 12 months - that level of operations is not going to work.

I argued in an interview last week with USA Today that the termination of most of the USC program agreements was mutual - USC needed to drop 2U, and 2U needed to drop USC.

Hill said he believed 2U might have had equal reason to distance itself from USC.  In addition to the legal challenges, 2U has said it's trying to work with schools to lower tuition. 

“That argument falls flat when you say, ‘Wait, your most profitable program and the core partner you’ve had charges $100,000-plus for a master’s of social work,” Hill said. “It ruined 2U’s story. And USC clearly needed to try to make a change, so I truly believe it was mutual.” 

But looking at the balance sheet, there is another reason that 2U needed to end those partnerships. Cash. As stated in the company earnings call:

When we and our university partners agree to discontinue a program, our partner agrees to pay us a fee, which we recognize as revenue when the agreement is signed.

Actual cash payments are scheduled in the agreement and occur over the next 12 to 24 months. From a cash flow standpoint, portfolio management generates near term cash that strengthens our balance sheet and provides us with the flexibility to launch new programs and invest in our growth areas.

And later in the call:

In that life, in the third quarter, we mutually agreed to transition out of certain degree programs with a client where we believe the long term future of those particular programs was challenged. This resulted in revenue in the quarter of $26 million related to the fee the university agreed to pay in connection with the transition. Early in the fourth quarter, we also mutually agreed to transition out of certain degree programs with USC. This will result in revenue in the fourth quarter of approximately $40 million.

In other words, 2U’s “portfolio management” efforts to “transition out of certain degree programs” is also intended to generate short-term cash, mostly to deal with the debt problem.

But the combination of cash and likely cash flow (augmented by portfolio management) is in the neighborhood of $150 million, not nearly enough to handle the debt obligations.

This means that the only way 2U survives is if it can renegotiate or refinance the debt.

This situation is analogous to the 2000s era mortgage market. Imagine buying a house where there is no way to pay off the low-interest, low-down payment mortgage based on your salary, and instead you rely on the future ability to refinance with a new mortgage. But the mortgage market changes, requiring 20% down payment and much higher interest rates. The analogy only goes so far, however, as banks are far more experienced and likely to repossess and sell a tangible house than are corporate bond holders to possess or control a technology company. The debt holders want their money back without too much operational fuss.

It Gets Worse

The driving debt is a $330 million term loan facility at 2.25% interest and initially due in May 2025 (the proceeds were slightly less at $320 million, and current payoff if closer to $380 million). In its 10-Q filing, 2U called out the risk based on its January 2023 extension of the term loan [emphasis added].

On January 9, 2023, the Company entered into an Extension Amendment, Second Amendment and First Incremental Agreement to Credit and Guaranty Agreement, dated as of January 9, 2023 (the “Second Amended Credit Agreement”), which amended the Company’s existing term loan facilities, previously referred to as the Amended Term Loan Facilities. The provisions of the Second Amended Credit Agreement became effective upon the satisfaction of certain conditions set for therein, including, without limitation, the funding of the 2030 Notes referenced below and the prepayment of certain existing term loans to reduce the outstanding principal amount of term loans outstanding under the Amended Term Loan Facilities from $567 million to $380 million. Pursuant to the Second Amended Credit Agreement, the lenders thereunder agreed to, among other amendments, extend the maturity date of the term loans thereunder from December 28, 2024 to December 28, 2026 (or, if more than $40 million of the Company’s 2025 Notes remain outstanding on January 30, 2025, January 30, 2025) and to provide a senior secured first lien revolving loan facility to the Company in the principal amount of $40 million (the “Revolving Loan Facility”). The termination date for such revolving loans will be June 28, 2026 (or, if more than $50 million of the Company’s 2025 Notes remain outstanding on January 1, 2025, January 1, 2025). If the Company does not refinance or raise capital to reduce its debt in the short term, and in the event that the maturity date of the outstanding term loan balance of $372.4 million springs forward to January 30, 2025, the Company’s liquidity may not be sufficient to pay off the balance on the accelerated maturity date if the Company does not otherwise sufficiently increase revenues, realize additional operating efficiencies and reduce its expenses. As of September 30, 2023, outstanding borrowings under the Revolving Loan Facility were $20 million and available borrowings under the same facility were $20 million.

In other words, if more than $40 - $50 million of the $330 million loan (called the 2025 Notes) is outstanding as of January 2025, that loan will be due immediately, and additional revolving loans will spring forward to the end of January 2025.

2U disclosed that it likely won’t have the liquidity to pay off its debt absent major, existential changes.

Visualizing the Situation

It might help to visualize 2U’s situation by showing key balance sheet metrics since its 2014 IPO along with the changing climate for corporate lending (by looking at the Fed Funds Rate).

Until early 2019 and the acquisition of bootcamp provider Trilogy, 2U maintained very little debt while keeping cash & equivalents between $50 - $400 million. In 2019, 2U secured $250 million in debt to help finance the $750 million acquisition of Trilogy while paying a significant portion with cash already on hand. It should be noted that Trilogy had significant growth at the time, and that it (along with the previous GetSmarter short courses acquisition) created 2U’s Alternative Credential segment) became 2U’s growth engine and likely paid for itself.

The bigger changes happened during the pandemic, particularly when 2U secured $475 million in debt to help with the $800 million acquisition of edX. At the end of this transaction, 2U held roughly $200 million in cash & equivalents, but that number has steadily dropped to the level of roughly $41 million.

Note the Federal Funds Effective Rate in red. What is most important is that it started rising - dramatically - two quarters after the completion of the edX acquisition. While this rate is not the same as a corporate term loan rate, it drives much of the cost of borrowing. Loans got much more expensive starting in 2022.

The issue with 2U is not so much that it is paying more on its debt due to this rise in inflation-driven borrowing costs, it is that refinancing debt has become much, much more difficult and expensive at a time when 2U needs to refinance.

2U’s History of Accessing Cash

2U has a history of generating cash by selling additional shares of its stock. When a company goes public, it holds an Initial Public Offering (IPO), and in 2U’s first year it had offered roughly 41 million of the 200 million authorized shares. Publicly-traded companies can offer additional shares in a formal SEC-regulated process, and 2U has used this process to raise cash over time.

The view below adds additional annotations on additional public offerings and shows the company share price below.

The key post-IPO public offerings to consider (in rough terms, unadjusted for inflation):

  • $70 million in 2015

  • $210 million in 2017

  • $300 million in 2018

  • $300 million in 2020

Note that the $475 million in 2021 debt along with the $300 million in public offering roughly covers the $800 million purchase price of edX.

One problem that 2U faces today is that the share price is so low that the company no longer has the ability to leverage public offerings in the same way it has in the past. Currently 2U has roughly 121 million shares remaining that have not been offered, and the current share price was just above $2 before the earnings release (and $1.05 today). There is roughly $120 million that could theoretically be raised in an offering, but the real number would be far lower as additional public offerings can dilute shares, and the company likely doesn’t want to empty its remaining authorized shares.

Summary of Situation

What this all means is that 2U is running out of cash, is relying on fees from terminating partnership agreements to boost future cash flow, and has run out of the opportunity to raise significant funds from additional public offerings. There is no apparent way for 2U to meet its debt obligations by 2025.

There are two implications here.

  • Debt holders are in control - 2U is out of options, and the stock market holds roughly $86 million in equity (market capitalization). Debt holders control in aggregate $980 million - whether they want to be or not, they are in control.

  • Bankruptcy is increasingly likely - 2U could pursue a structured bankruptcy to alleviate its debt obligations while continuing to operate the company. Keep in mind that we have seen EdTech companies successfully manage bankruptcy, such as Cengage from 2013 / 14. In fact, there are signs that the markets already understand 2U’s situation.

Debt holders are in control, and they will determine whether to refinance the debt, whether to force 2U into bankruptcy, and whether to sell of any assets such as the Trilogy bootcamps to help pay off debt. 2U and its new CEO are obviously part of the process, but they are not in ultimate control.

While we’re on the topic of 2U executives, I find it strange that the CFO who was in place and in charge of the key financial decisions that helped lead to 2U’s current situation has been elevated to CEO.

What This Means

If my analysis is correct, this means that 2U is facing an existential change in 2024. The company will likely survive, but it will undergo some significant changes from bankruptcy, from selling off assets, from additional layoffs, or more likely from some combination.

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