Is 2U Just Another Pets.com In Slow Motion?

With 2U unable to cover the interest payments on its mountain of debt, acquired to pay for a series of acquisitions it bought at wildly inflated prices, the company had no choice but to file for Chapter 11 bankruptcy. Few were surprised by the move or the 2U far-fetched posturing that getting the protection of a bankruptcy court is a “strategic action to significantly strengthen (its) balance sheet and position the company for innovation and growth.”

This is a failed online program management (OPM) company that never managed to make a profit over the 16 years of its existence, with net losses totaling $317.6 million last year alone. In fact, 2U has lost money in each of its nine years as a public company, with its total deficit over the past five years surpassing $1.2 billion. For 2024, the company is already predicting yet another loss of $90 million to $85 million.

The only difference between 2U and Pets.com is that the latter company fell apart more quickly in the massive dot-com bust of 2000. 2U, on the other hand, has taken the slow road to collapse, long riding on the unrealistic hopes of investors in its own Ed-tech bubble. By spending big, 2U has managed to land many highly admired universities as partners, including business schools which depend. on it for marketing and managing 10 different online MBA programs as such prestige B-schools as UNC Kenan-Flagler, Rice Jones, and UC Davis.

2U SPENT $2.6 BILLION TO RECRUIT STUDENTS FOR ITS PARTNERS IN THE PAST TEN YEARS

But the reality is that what crashed Pets.com is exactly what crashed 2U: a badly flawed business model from its early days. Advances in technology, which initially opened the door to a lucrative market for 2U, is what destroyed its business model. Within five years of its founding, schools could easily do what 2U promised to do for a fraction of the cost with off-the-shelf technology, gig workers and Google keywords.

As one business school dean tells Poets&Quants: “On a technology standpoint, I thought early on that 2U’s technology was new and novel and ahead of its time but by 2013 we had people say, ‘I can produce my own class.’ I have people who know the technology. And we started doing more inhouse which turned them more into a marketing company.”

And not a very good one. The most glaring evidence of 2U’s broken business model was not merely its inability to move into the black. It was the consistently outrageous amount of money it spent on sales and marketing to persuade students to take the online courses from its partners. In the past ten years alone, 2U spent $2.6 billion on sales and marketing, roughly 49% of all its revenue in those years. In its early years–2011 to 2013–the company’s marketing expenses accounted for 108.0%, 81.2%, and 65.1% of its revenue. At its peak, those expenses totaled $456.1 million in 2021 (see table below).

2U’s MARKETING COSTS WERE OFTEN MORE THAN HALF ITS REVENUES

Put into perspective Coca-Cola, one of the world’s premier marketing companies, spent 16.6% on sales and marketing last year. As one analyst has noted about 2U massive expenses in getting student customers, “Buying keywords on Google, Facebook, Microsoft Bing, Yahoo, and other online social media platforms, optimizing them through SEO (search engine optimization) techniques, and converting them to leads are what drive up the marketing costs per new student to $5,000 or more.” Once the pandemic forced every school online, the cost of these keywords doubled and tripled.

Just like Pet.com, the company soared on the exuberance of its investors. 2U’s stock price ballooned from $13 at 2U’s 2014 IPO to a high of nearly $99 four years later as demand increased for the company’s online education offerings. At its peak, 2U had a market cap of more than $5 billion. All trading in 2U stock, with the decision by the Nasdaq exchange to delist the company in late July after its bankruptcy filing, was officially suspended on Aug. 7.

The sock puppet, the once ubiquitous symbol of Pets.com, must be turning over in his grave.

‘NOBODY IS GOING TO RENEW ON THEIR ORIGINAL TERMS’

Once 2U emerges from its pre-packaged bankruptcy by the end of September, it can’t be business as usual. While schools are tied into long-term contracts, handing the OPM 60% of its tuition revenues, they will be working with a greatly diminished partner, with fewer employees to service those contracts and significantly reduced marketing budgets to help recruit students for their degree and non-degree programs. And 2U’s college partners never even got the remaining 40%. After paying the salaries of faculty and staff for their work with 2U programs, their cut comes closer to 24%. If 2U support of those programs leads to dissatisfaction, a college could get out of its contract with the company.

“Nobody is going to renew on these terms and no school that wasn’t desperate was going to sign that contract, either,” says a long-time observer of 2U misfortunes. “For a while, 2U paid up to $6 or $8 million to induce universities to sign a contract. And even that stopped working. At that point, what was a growth story turned into a wasting asset.”

Instead of fixing its broken business model, Paucek chose to overspend on a series of acquisitions. In 2017, 2U bought a little known South African company called GetSmarter for $103 million. In 2019, the company paid roughly $750 million to buy Trilogy to get more university partners. Two years later, 2U acquired the online learning platform edX. Instead of using the inflated value of its stock, 2U chose to pay about $800 million in cash for edX and $400 million in cash for Trilogy. Those deals were largely predicated on the belief that the non-degree programs in the portfolios of GetSmarter, Trilogy and edX would act as a funnel to the degree programs.

‘THEY OVERPAID FOR BUSINESSES BECAUSE THEY WERE PANICKED’

It never happened. “They decided to go all in on non-degree programs and in very case, whether Trilogy or edX, they paid a higher premium over the number two bidder,” an insider says. “They overpaid wildly for businesses because they were panicked about the degree space and then they expected  growth that never happened.

“They believed two things,” he continues. “One, that they could just fool people for longer by creating a more and more confusing story (with the acquired revenue from those deals). And two, the justification for over paying was this thought that there a pipeline or funnel of non-degree or certificate learners who would later decide to take a degree program. But if you are trying to convince someone to enroll in a serious MBA program, what ever is in the MOOC is not compelling. It doesn’t capture relationships to other students and faculty. It’s just lecture. There is no pipeline. The number of students who became learners in the non-degree stuff is in the hundreds.

“Instead of adapting their model to a new world, they just tried to change the conversation. Who is buying 2U right now will grit their teeth and say we are going to make this model work but they are just kicking the can down the road.”

‘WORKING WITH A ZOMBIE OPM’

What does all this mean for 2U’s partners, including the ten business schools have have online MBA programs with 2U? “The worst case scenario for every university when you work with a zombie OPM is that it doesn’t have the capital to invest sufficiently in your program,” adds one observer. “You stay small and they are getting you the students you would get anyway. You don’t need to pay a partner 60% to 70% of revenue. The point is to do that only if it is better than what you are doing in-house.”

2U parted with its long-time CEO Chip Paucek in November after paying him $41.1 million in the past four years in cash pay and equity awards. Those stock awards are not worth nearly as much as they were when originally valued but the company’s separation agreement with Paucek now provides him with monthly consulting fees of $20,000, continued eligibility to vest in his outstanding equity awards and, upon completion of his consulting period, a further payment of $183,333.

In all frankness, Paucek should have lost his job by the end of 2019 when net losses ballooned to $235.2 million from $38.3 million in 2018. Paul S. Lalljie, 2U chief financial officer who was been watching the money leaked out of the company for five straight years of failure, has succeeded Paucek as CEO. On Glassdoor, he has a meager 19% approval rate as CEO.

‘ATTRITION IS HIGH AND MORALE IS IN THE TOILET’

A 2U manager, writing anonymously on the Glassdoor platform last month, gives little hope for the future.
“It’s (a) failing company, (with) terrible management, no growth opportunities, endless layoffs. The executive level awarded themselves massive bonuses in the millions that are not linked to performance or any other metric – they just have to stick around through the final death rattles of the organisation. I do not believe that this company is going to be around by this time next year…I don’t think it’s going to survive, at least not as a single entity or with all of the product lines intact. Colleagues (are) praying to get laid off, others are leaving without other jobs linked up, and others are just stuck because fully remote work is harder to find right now and the job market is bleak. Right now it seems like there is no hope at the end of the tunnel, attrition is high and morale is in the toilet.”

Many are trying to figure out what 2U bankruptcy filing means for the future of OPMs. Is this the beginning of the end? Or is 2U something of an anomaly? John Katzman, a serial entrepreneur who founded The Princeton Review and 2U and now runs rival Noodle, still believes that OPMs have a future in higher education. “What the for-profit sector can do for higher education is really important. We bring economies of scale, technological expertise and investment and network effects. A school can’t do those things for itself, even a large system. So there is a place for the sector but look at the letters OPM. O stands for online, and the future of higher ed isn’t online. It is agile.

“There is one system,” explains Katzman. “A student may study solely online and another one may be solely on campus but you don’t have two separate systems. They are all your students. Home Depot doesn’t care where you buy the hammer, whether at one of its stores or off its website. A great majority of online students live within commuting distance of their campus. How are you addressing them? How are you enticing them to show up on campus even if they are taking courses online? This is especially important for a business school where relationships are key. Part of it is a marketing problem, part of it is a product problem, or a student service problem. This isn’t rocket science but the change is hard.”

In all likelihood, 2U will not be in a position to answer that question. But the deans and administrators who are 2U’s partners will have to figure that out for themselves.

2U SPENT ENORMOUS MONEY BUYING STUDENT CUSTOMERS FOR PARTNERS

In the past ten years alone, 2U spent $2.6 billion on sales and marketing, roughly 49% of all its revenue in those years.

Year	Net Loss	Revenue	Sales & Marketing Costs	% Of Sales & Marketing Expense Of Revenue
2023	$317.6 million	$946.0 million	$372.1 million	39.3%
2022	$322.2 million	$963.1 million	$422.1 million	43.8%
2021	$194.8 million	$945.7 million	$456.1 million	48.2%
2020	$216.5 million	$774.5 million	$390.2 million	50.4%
2019	$235.2 million	$574.7 million	$342.4 million	59.6%
2018	$38.3 million	$411.8 million	$221.0 million	53.7%
2017	$29.4 million	$286.8 million	$151.0 million	52.6%
2016	$20.7 million	$205.9 million	$106.6 million	51.8%
2015	$26.7 million	$150.2 million	$82.9 million	55.2%
2014	$29.1 million	$110.2 million	$65.2 million	59.1%
2013	$28.3 million	$83.1 million	$54.1 million	65.1%
2012	$23.1 million	$55.9 million	$45.4 million	81.2%
2011	$24.9 million	$29.7 million	$32.1 million	108.0%

SOURCE: 2U annual reports