Chegg falls 6% as Morgan Stanley downgrades on continued AI risks

Shares of Chegg (NYSE:) fell nearly 6% in pre-open Monday trading following a downgrade by Morgan Stanley analysts to Underweight from Equal Weight.

The price target is cut by $1 to $9 per share.

Analysts cited weaker trends observed in October and anticipated increased competition from generative artificial intelligence (AI) in the long term.

“While we have been cautious on Chegg for the last couple of years, the market has been quick to penalize the stock,” the analysts said.

Still, the downgrade move comes after the stock rallied about 40% off October lows.

The analysts highlight 5 key factors supporting the rating downgrade.

1. Share Outperformance and Weaker Trends: The recent share outperformance is juxtaposed with observed weaker trends in web traffic and app downloads, indicating a potential disconnect between market sentiment and operational performance;
2. Consensus Estimates: Analysts believe that consensus estimates for Chegg remain too high, setting the stage for potential negative estimate revisions in the future;
3. Q4 Subscription Revenue Guidance: Analysts also cite concerns about Q4 subscription revenue guidance being perceived as aggressive;
4. Unit Economic and Retention Math: Morgan Stanley’s report presents illustrative unit economic and retention calculations, highlighting an increasing reliance on gross subscriber additions to meet consensus targets; and
5. ARPU Dynamics: The potential for an unexpected shift from an Average Revenue Per User (ARPU) tailwind to an ARPU headwind is mentioned.

“We lower our multiple based on these risks, resulting in our price target of $9. $9 implies ~6x CY25 EV/EBITDA, more appropriate than current trading levels >1x higher given negative growth, declining margins, the likelihood of negative consensus estimate revisions, its challenged risk vs. reward, and a valuation more in line with its peer regression line,” explained the analysts in the downgrade report.