Analysis: ChatGPT Crashes Chegg’s Stock 50 Percent in One Day

Online education firm Chegg’s stock crashed by almost 50 percent on May 2 after the firm said Open AI’s ChatGPT was hurting its business. Overnight, Chegg lost $1 billion in market capitalization after acknowledging that increasing numbers of students are using free chatbots to help with homework instead of paying for its study aids. The stock has not recovered, and the company is now worth only a third of its value when ChatGPT launched in November 2022.

The Santa Clara, California education company earned $767 million in 2022 by selling subscriptions to its online platform that offers college students help with homework and exam preparation, along with value-added services like online tutoring. The firm’s database reportedly contains more than 79 million solved problems and model answers—potentially the largest collection of such academic data in existence—including popular step-by-step solutions to commonly asked questions.

On the company’s earnings call, the firm’s CEO Dan Rosensweig told analysts that “in the first part of the year, we saw no noticeable impact from ChatGPT on our new account growth, and we were meeting expectations on new signups. However, since March, we saw a significant spike in student interest in ChatGPT. We now believe it’s having an impact on our new customer growth rate.”

This appears to be the first known instance where a publicly-traded company admitted that an artificial intelligence platform had hurt its business, and the earnings declines were significant. On the call, Chegg reported a 7 percent decline in revenue compared with the first quarter of 2022. The firm’s revenue forecast for this year’s second quarter ranges between $175 and $178 million, significantly below the $193.6 million predicted by the analysts at FactSet. Moreover, Chegg also withdrew its earnings guidance for the remainder of 2023.

Chegg’s report dragged down other education and edtech stocks as well. In London, the world’s largest education company Pearson lost more money in capitalization than Chegg did; Pearson lost 15 percent of its $7.91 billion market cap, or about $1.19 billion.

Furthermore, the foreign language learning company Duolingo’s stock sank by about 14 percent before it started rebounding again on May 4, but not before shedding $820,000 in market value. Online course provider Udemy also got caught up in the selling frenzy, with its stock dropping by about 5 percent.

No sooner did the news of Chegg’s crash cross the wires than equity analysts, mostly caught off-guard by the news, started to announce their stock downgrades. Yet had they merely dropped by for lunch at a nearby college’s student union three months before, they would have noticed ChatGPT on many of the students’ computer and mobile device screens. Some of those analysts might have been wise to announce their downgrades back then.

In April, the average one-year price target for Chegg was $20.78. As soon as the crash hit, Goldman Sachs dropped their price target to $14. Northland Capital Markets analyst Mike Grondahl then followed suit, downgrading Chegg from an “outperform” rating to a “market perform” rating and reducing his price target to $15.

The Wall Street investment bank Jefferies was also one of the first out of the gate to slam Chegg. In a tersely-worded research memo titled “Ran Out of Hall Passes: Downgrading to Hold,” analysts Brent Thill and David Lustberg downgraded Chegg from a “buy” rating to a “hold” and slashed their price target 56 percent, from $25 to only $11.

Thill cited existential fears about AI as the main reasons for his team’s forecast, telling Reuters how fears now exist that Chegg’s core business could become extinct as their customers experiment with free artificial intelligence tools. That’s to say that students might choose free AI tools like ChatGPT, Bing AI, and Google’s new Bard to help them study instead of paying $240 each year for Chegg’s subscription services.

“Legitimately, their entire business could be disrupted,” Thill told the Wall Street Journal. He criticized Chegg for not having diversified into other lines of business so the firm’s revenue from its core subscription service wasn’t as vulnerable.

That need for diversification seems especially acute given the niche market that Chegg serves. Because college students are cost-sensitive, they are typically open to more affordable alternatives than a product like Chegg’s, which will set undergraduates back almost $1,000 over four years. And no disincentives discourage or prevent flighty students from defecting to competing alternatives like ChatGPT that are “priced to sell.”

Although acknowledging Chegg’s traditionally strong customer retention rates, the team also doubted Chegg’s capacity to keep pace with the faddish, viral spread of new AI tools. “While retention rates of [Chegg’s] existing customers remain strong now, we fear that student usage of A.I. tools like ChatGPT could cause a viral sensation around campus (just like [Chegg] had benefited from), which could increase churn in the coming quarters,” they write in their memo.

Talking about AI’s impact, Thill added, “I think what everyone’s having a hard time understanding is how they didn’t see it coming.” Indeed, to knowledgeable observers within higher education, the apparent trend where students quickly shifted away from Chegg towards ChatGPT came as little surprise.

Only seven weeks after OpenAI’s release of ChatGPT, on January 23, a nationwide poll of 1,000 U.S. college students had already revealed that almost a third had used ChatGPT to complete their written assignments. The survey conducted by the Seattle-based Intelligent Magazine also found that nearly six in ten were using the chatbot on at least 50 percent of their work.

About 76 percent of the poll’s respondents said that the chatbot was popular with other students. And even though another 76 percent considered using ChatGPT on written assignments to be cheating, they did it anyway.

Now, along with these survey results, keep in mind the phenomenal market penetration rate of Chegg’s popular service among students in higher education. In 2022, Chegg claimed 6.2 million subscribers, and in 2021,17.7 million college and graduate students were enrolled in the United States, according to the National Student Clearinghouse Research Center.

That means Chegg claims a staggering 36 percent penetration rate. To put that in perspective, most consumer products like dishwasher detergent or paper towels have penetration rates in the 2 to 6 percent range.

Can such a high penetration rate really be accurate? Look at it this way: Aside from Chegg, these days, ambitious students can still buy supplemental solved-problem textbooks like the classic Schaum’s Outline Series by McGraw Hill or REA’s Problem Solver series—just like it’s still the 1980s or 1990s.

But when students can obtain nearly 80 million such solved problems on demand online in seconds, with the ability to ask their own 20 novel questions a month to Chegg’s staff of 70,000 subject-matter experts in India and pay as little as $20 a month, why accept substitutes? Glance through TikTok and one will find video upon video where college students brag about how buying their Chegg subscription was the “best $20 a month I ever spent.” That penetration rate of almost two-fifths of all students definitely seems credible.

So, other things equal, we would expect that at least 36 percent of those randomly-selected survey respondents who told the pollsters that they were using ChatGPT were also Chegg’s customers. More accurately, these days they’re also potential defectors. And it wasn’t only the pollsters who were paying attention to them back in January.

At about the same time, college faculty noticed this shift from Chegg to ChatGPT, and some had started reporting their observations on social media. For example, Parkev Tatevosian, a finance professor at California State University in Los Angeles, warned his YouTube followers in January that Chegg was vulnerable to disruption by ChatGPT.

“Being a university professor myself and being on campus as often as I am, I saw how students were using ChatGPT and how they stopped using Chegg, and I was able to sound an early warning,” he says. “I saw the big changes happening on campus already.”

Advising his followers that this “dip” doesn’t exactly look like a buying opportunity for Chegg’s stock, Professor Tatevosian continues:

This is not one where you’re like, “Oh should I buy this on the dip?” The answer is no, absolutely not. . .

It’s an opportunity to sell it before it goes down even more because the entire business model in my opinion is in question. The entire competitive advantage was thrown into question by what ChatGPT offers.

Now, they may be able to find a workaround; they may be able to find a way to utilize ChatGPT to enhance their own services. I wouldn’t be counting on that.

Actually, Rosensweig now says that Chegg plans to integrate artificial intelligence into its services. To do that, he says the firm plans to introduce a new service called CheggMate that it will build using OpenAI’s GPT-4 model. “There’s been a technological shift, and we need to prepare for it,” he told the Journal.

Nevertheless, most Wall Street analysts agree with Professor Tatevosian. For example, the Jeffries analysts wrote that even though Chegg plans to start rolling out this service later in May to a few customers, they say that “the timing of a full launch is unclear,” and that they don’t expect “any meaningful impact” from the CheggMate service until the 2024 fiscal year.

Furthermore, analyst Josh Baer at Morgan Stanley wrote in a research brief that “the optimistic scenario of the new AI-powered ‘CheggMate’ solution insulating Chegg from external risks is highly unlikely.” And Piper Sandler analyst Arvind Ramnani also told the Journal that Rosensweig’s ChatGPT discussion left “more questions than answers,” while it’s not apparent that CheggMate will be able to withstand the threat from newer AI tools along with ChatGPT.

“We believe that Chegg has to make significant changes in a rapidly changing environment that is akin to ‘dancing in the rain without getting wet,’” Ramnani said.