The internet has transformed the way people engage with entertainment over the past 20 years, with a growing trend towards paying subscriptions to use the likes of Netflix and Spotify on an ongoing basis rather than renting or buying individual DVDs and CDs.
And Baillie Gifford’s Malcolm MacColl thinks the industries that have been built up to support higher education over the past couple of centuries are now just as vulnerable to disruption as record shops and video rental stores were at the turn of the millennium.
MacColl is the deputy manager of the Monks Investment Trust, made up of a portfolio of 90 stocks, about a quarter of which are in small position sizes of no more than 0.65 per cent.
While many fund managers claim one of the keys to outperformance is having a strong conviction in their best ideas rather than diluting their returns through diversification for diversification’s sake, MacColl takes a different view.
The manager said these small “incubator holdings” have a wide range of potential outcomes and allow him to take advantage of the asymmetry of returns, where the downside is capped at 100 per cent, but the upside is limitless.
“Initially taking smaller positions in starter holdings allows us to get beyond the normal behavioural pitfalls of owning these companies,” he explained.
“It enables you to own a business like Tesla, which we first bought at $30, and see it come up through the portfolio.
“When we look at the way in which value has been delivered for the fund over time, the smaller holdings have more than punched above their weight. So, this is something we deeply believe in.”
Source: Baillie Gifford
One of the incubator holdings MacColl is particularly excited about is Chegg, which describes itself as an “on-demand education services platform”.
The company originally launched as an academic textbook-rental company, but when competition from the rise of Amazon made this business model unviable, it sold off its physical assets and pivoted itself to an online model.
“What it has today is an enormous question-and-answer bank which sits as a sort of crib sheet for students and an online immediate tutoring service,” said MacColl.
“If you have a subscription to Chegg, you can get 24/7 access to tutors who will answer your questions for you there and then. They then take that bank of questions and open it out to all of the other users, making the thing increasingly valuable all of the time.
“It’s got 3.1 million users today and we think it has got the potential to scale up to a much more significant size. Only yesterday I was looking at some of the upside numbers and thinking about where it could get to in the next five years. I think this thing could easily get to about 12 million users.”
There are two aspects about Chegg in particular that appeal to MacColl, the first of which is its ambition. For example, the manager said that while it is easy to understand the current value of the service to students and the way it is helping them with their studies, the company is now talking about turning the world of education on its head and moving it towards an on-demand model.
“It wants to deliver education in a student-first manner, as opposed to a manner that is arguably geared towards the satisfaction of quite inert institutions,” he continued.
“Its ambitions aren’t just about being a tutoring service, it wants to go a lot further into different areas of certification, teaching and such like.
“It’s something that captures my imagination a little bit. Maybe it’s something to do with the way I was taught, but I think it is really exciting.”
The second aspect of the company that appeals to MacColl is the ease with which it can scale up. One of the major problems experienced by small- and medium-sized businesses when they attempt to move up to the next level is the ability to acquire customers at a reasonable cost, which needs to be weighed up against the lifetime value, or the total revenue a business can reasonably expect from a single customer account.
However, the manager pointed out Chegg’s cost of acquiring customers is extremely low as 85 per cent of new business is made through students approaching the company, rather than the other way around.
“It’s organic traffic, it’s by word of mouth because it has a huge brand presence within American campuses and it has very strong search engine optimisation,” he continued.
“Again, this is something you will hear and ask, ‘what does that really mean?’ It means that whenever it is asked a question from the back of a text book, meaning one it gets asked quite a lot, it puts the answer out and makes it completely open on the internet.
“That means that when you type in ‘what is the answer to this particular question?’ on Google, it [Chegg] is the one at the top of the search list.
“People click through and say ‘this Chegg thing is pretty darn useful to me. Oh, wow, I can get that for $14.95 a month,’ and very few people say no to it.
“It has huge ambition, it is very inexpensive and it is turning the education system upside down.”
In May last year, Alex Wright of the Fidelity Special Situations fund told Trustnet he had bought into heavily shorted education publisher Pearson, saying the market had underestimated the cost-savings and opportunities available in the switch to a digital model.
The stock has continued to struggle since then, however, and its shares plunged by close to 20 per cent in a single day at the end of September on a profit warning.
Performance of stock over 5yrs
Source: FE Analytics
MacColl brushed off concerns that Chegg could experience similar problems, pointing out that it doesn’t have to deal with the legacy issues faced by its sector peer.
“There is clear value in the types of offerings the likes of Pearson have and I don’t just mean in terms of cheapness,” he added.
“But what I’d be a little concerned about with that type of model is it has not necessarily been delivered in what I would regard as a student-first way.
“Now they are looking at different forms of distribution, which can tackle some of those issues. But it is very difficult for a business which has grown up in that fashion to pivot aggressively and move into a more modern environment where people’s demands are very different.
“People want to learn in different ways and people want to pay for that learning in different ways.
“With the likes of Chegg, this is education for the Netflix generation, for people who want it here and now and don’t want to pay top prices that they would regard as gouging.
“It’s a different way of doing things.”
Data from FE Analytics shows Monks Investment Trust has made 116.99 per cent since the current management team took charge in March 2015, compared with gains of 69.54 per cent from the IT Global sector and 67.38 per cent from the FTSE World index.
Performance of trust vs sector and index under management tenure
Source: FE Analytics
The trust is on a premium of 3.54 per cent compared with 3.44 and 1.32 per cent from its one- and three-year averages.
It is 6 per cent geared and has ongoing charges of 0.5 per cent.