Buzzy College Textbook Company Chegg Isn't Profitable - Here's Why

Ashton Kutcher promotes Chegg on Two And A Half Men.College textbook rental service Chegg — whose most famous investor is actor Ashton Kutcher — is not profitable and has greater negative cashflow from buying textbooks than it has in positive cashflow from its operations renting them to students.

Chegg filed S-1 papers with the SEC for an upcoming IPO yesterday. It is expected to raise $150 million in a public stock sale.

While Chegg's business is growing, a deep dive into its accounts shows that it has a more complicated business model than might be expected from a company that, basically, rents textbooks cheaply to students so they don't have to pay the greater price of buying them outright.

First, it's important to note that Chegg's business is big and robust. It has 614 employees, and its revenues are growing. Its 2012 revenues were $213 million, up 24%. Revenues were up 15% in 2011 from the year before, and in 2010 they tripled from the year before that.

So clearly Chegg is doing something right — there is growing demand from students who are disaffected by publishers who want to charge them more than $100 for a book that is only useful for a single semester.

But Chegg has never made a profit doing this, at any time. It has only ever recorded both operating losses and losses on the bottom line:

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One reason for that is the cost of doing business at Chegg: The company must buy new textbooks every year, which are very expensive. Then, a short time later, after renting them to students, it sells the used book. But as everyone knows, a used college textbook is often out of date and therefore worth much less (professors tend to update their textbooks every year, especially when they are assigning books they have authored themselves).

In the first six months of 2013, Chegg spent $42 million acquiring texbooks, according to the investing section of its cashflow statement. It got $21 million from liquidating old textbooks. So Chegg's main assets — textbooks — are always in fast decline, giving the company a cashflow headache. Overall, Chegg's investment cashflow was negative $24 million.

However, Chegg had revenues of $116 million in the same period from book rentals. But, the cost of marketing and delivering those books made the company lose $18 million in operating profits. It did, however, see positive cashflow of $22 million from operations.

You can see how complicated this is: Chegg both rents new books and liquidates old books. But the cost of renting the books and the cost of investing in new books always seems to be slightly greater than the revenues Chegg can get from renting them and the profits it can make from liquidating out-of-date books.

Here's what that looks like on its simplified cashflow statement:

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That's possibly one reason why Chegg presents this "non-GAAP" (meaning unofficial, in accounting language) representation of how it believes it is meaningfully profitable:

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Chegg is profitable, it claims, if you ignore interest, "other expenses" and taxes. That's not an unreasonable ask — those items are not huge bills in Chegg's business.

There are signs that Chegg is scaling into a mature, profitable business. Its loss from operations has narrowed significantly over the last three years, and it's now down to 15% of its revenues in the first half of 2013, from 33% last year.

So while the business is complicated, it is not impossibly so: Chegg gets cash both from renting books and selling old ones. The bigger it gets, the fewer books it needs to buy per customer, and the more profitable it becomes, both in terms of the bottom line and temporary cashflow.

Kutcher appears to have backed a potentially solid business.