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The Letter From: What I Learned at the Signal Hill Education Preview Investor Conference

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I have gone to one, two or more conferences sponsored by investment bankers showcasing publicly traded firms in education every year since 1991, and have a collection of increasingly elaborate tote bags to prove it. The carriers, used to store the volumes of financial and marketing materials prepared by firms presenting at the conferences, have gone from flimsy cloth affairs with an imprint of the organizers’ logo - perfect for sunglasses, a water bottle and a beach towel - to multi-functional laptop cases with the investment bank's name embroidered in some prominent location. In the 1990’s, I also came home with a nice pen. This last trip to Signal Hill’s November 27 conference yielded a 125MB thumb drive.

Conference freebies have changed, but not the format. CEO/CFO teams give a 20 minute PowerPoint presentation on their firm and its finances. Each of these “dog and pony shows” is followed by a few minutes of questions from the audience. One nice feature of the Signal Hill Conference was moving the presenters to a separate room for more interactive sessions.

An educator, eduwonk, evaluator or k-12 program developer attending the conference would probably be struck by two things.

First, the real substance of the presentations is financial – unsurprising since this is a conference for investors, but nonetheless striking. More on this below.

Second, it’s a very polite affair. Eduwonks and evaluators learn by taking presentations apart, asking pointed questions and lively debate. Investors tend to ask few questions and those are to clarify the financials. This is also my impression listening into the quarterly conference calls firms' schedule for investors.

With training in law and analysis, I learn by asking pointed questions. I’m less interested in the financials – which I can read online whenever I want – than the strength of the business strategies. What I find important about investor conferences is: first, the opportunity to judge a CEO’s grasp of environmental indicators and their implications for the business; and second, the gestalt of the conference, the collective perception of industry status and trends. I also pick up a few interesting factoids that might prove to be indicators of change.

Here’s what I learned from the Signal Hill session:

The "Safe Harbor" statement is so important the slide must be shown but never seen.

The general rule of thumb for audio-visual presentations is to never place more than three to five bulletized points on any slide, and to leave it up long enough for the points to register with audience.

Publicly traded firms are required to explain the material risks investors should consider before putting money into their stocks. Providing a chart with a statement of these risks offers firms a "safe harbor" in the event of legal claims related to full disclosure down the road.

The Safe Harbor slide is generally a dense paragraph, waived in front of the audience just long enough for the presenter to tell his or her attorneys that it was in the presentation. They deserve more attention before the rush to the financials.

By definition, risks covered in the Safe Harbor slide: 1) could have a serious adverse impact on the company’s performance, and 2) are well enough within the realm of possibility to be worthy of investor attention. The slide is in the deck because it is important. Not talking about it defeats its purpose, especially since I'm not at all convinced investors could write a passable essay on many of the risks in the school improvement business. As it happens the salient risks are almost always outside the control of management. So understanding the extent to which management recognizes and has plans to cope with these risks is important to the future value of the firm.

What strikes me is that by zipping past the risks, CEOs are offering evidence of a failure to disclose that might come into a lawsuit from disappointed shareholders. By letting them do it, the investment firms are opening themselves up to claims of a lack of diligence. And by sanctioning the practice, the investment banks sponsoring the sponsors may be caught up as well. It just makes sense to me to make the dog and pony show include perhaps two minutes more on the risks and how the firm copes, and perhaps two minutes less showing the latest marketing materials.

The best way to bet on virtual education/e-learning/ online classes/cyberschools is to invest in a diversified k-12 provider with the financial wherewithal to buy the right business model and firm when the market shakes out.

There’s no doubt that more k-12 students will do more learning online at an increasing pace over time. The question is which business models and firms are going to make money meeting this need and have the potential to dominate their field. Some firms are trying to build a brand with parents through charter schools – Connections Academy; others are focusing on the high end of the market – Apex Learning with Advanced Placement courses; others are building an infrastructure that is invisible to the public at large, but known to k-12 administrators – eCollege. CEO’s from these providers spoke at the conference, but for every other company there’s another strategy towards profitability and scale.

I am taken by two emerging facts: First, online providers have so far received the same level of payments as their on-site competitors. The on-line providers don’t seem to realize it, but those fees will start moving in the direction of their costs. Maybe not today, but certainly over the next few years. Second, the days of the end-to-end online solution are numbered. There was a time when public education did not have the capacity to serve as its own general contractor and pull all the on-line learning pieces together itself. Today, there are an array of companies that can supply the various parts, and public schools' administrative capacity to manage the package will only improve. Both factors will tend to squeeze profits. My guess is that the publishers will watch the little guys compete, and buy up the victorious but exhausted firms left in the market.

It's worth noting that eCollege is already owned by Pearson; Connections Academy was sold by Sylvan Ventures to an investor group led by Apollo Management – implying an intent to follow suit; and Apex was founded by Paul Allen of Microsoft – which might be the deep pockets exception that proves the rule/my theory. These guys are betting that they will be the winners bought up. If you are betting on who will realize more absolute or expected value out of the sale to a publisher - investors in the online target or the publisher making the acquisition, my guess is the latter.

• Public schools can learn from the private sector.

Nobel Learning Communities has managed to remain outside the interest of eduwonks, although it runs the largest single private school district in the country with an average per pupil payment in the vicinity of $8000 per year. Yes, that means it doesn’t get the toughest or poorest students. But it does two things any school district should be able to copy – especially districts that have decided on a top-down uniform curriculum model for school reform. First, every week, every Nobel student goes home with a report of what they accomplished relative to where they ought to be in the school year – with examples of their work product, what’s going to happen next week and how parents can help. Second, as early as fourth grade, students in different schools (in different parts of the country) are collaborating on joint projects fitting into their common place in the curriculum. Wow.

• Demonstrations of educational effectiveness are incidental to investor interest in any given firm.

Net earnings certainly distill every factor that impinged on a firm’s past success. Market theory holds that the price of a firm’s shares also captures all information available at the time about its past and future

I don’t think the theory of share value works in practice, which is why some investor’s portfolios do better than market. Still, investors at these conferences are distinctly uninterested in whether a firm’s products and services actually improve student performance. They rush to the numbers because they see them as telling all they need to know.

Shame on investors. Their narrow focus on last quarter’s and next quarter’s numbers can only tend toward pack investing – and that can’t create unusual returns for the pack's clients.

I believe that understanding program performance issues is about as important to value creation today in k-12 as understanding engine technology was to bets on early automotive firms that did or did not become part of Detroit’s Big Three.

More important, shame on buyers. If school districts purchased solely on the basis of results adjusted for price - or even gave it some recognizable weight - investors would care a great deal more about which firms' offerings had an impact at scale in the classroom.

And so, shame on the U.S. Department of Education for the sham implementation of Scientifically Based Research requirements in No Child Left Behind. And shame on Congress for not paying attention to the seven year mess-up with better oversight.

Listen to this as a podcast here.

3 Comments

Marc -- As you have before I think you sell Wall Street short here.

With respect to disclosures the slide is a template that investors have seen many times before. The SEC's disclosure requirements are intended more for the benefit of retail investors, none of whom were in attendance. This is an audience of professional investors and if you think they don't consider the risks before investing, you are sorely mistaken.

As for tough questions, those take place in the private sessions to which you were not privy -- and they are plenty tough -- again pointing to the fact that these are institutional investors generally deploying tens of millions of dollars at a time.

As for whether Wall Street is sufficiently focused on the efficacy of the programs, I think they rightly recognize that that is only one element of what makes a firm successful. You are one that recognizes the dominance of large publishers, but surely you are not suggesting that somehow their dominance is the sole result of the quality of their texts. So investors look at the claims around efficacy... and they were there... but then they look at the track record in the marketplace based on sales performance. If they think the efficacy is sufficiently compelling, they will overlook a spotty historical track record and buy the stock. If the situation is reversed they will short the stock.

You were not the target audience for this particular conference, but you're welcome for the zip drive.

-- Trace

I do agree with your point about Nobel however. They use language that would make the educational establishment blanch, but recognizing the critical importance of parent communication is a lesson from which many public schools could benefit.

Trace:

Perhaps you are right about investors' perception and calculation of risk. However, mere assertion is not highly persuasive.

I would ask you to expand your response:

With regard to the Q&A sessions I did not attend, please give some examples of the tough questions that were asked on subjects other than finances, and specifically the kinds of risks outside of management's direct control that I mentioned in my posting. It is not necessary to name firms, just give readers a sense of the exchange.

(edbizbuzz readers should know that I was not kept out of these Q&A sessions. Trace was the perfect host. I participated in two, and in the other cases chose to listen to the ongoing presentations instead.)

On the assertion: "If they (investors) think the efficacy is sufficiently compelling, they will overlook a spotty historical track record and buy the stock." An example or two of instances where this has happened would be useful. Maybe Scientific Learning? Are there any others with credible demonstrations of performance at scale?

I would argue that the more likely case is a hyped IPO - where efficacy is utterly lacking, followed by vast disappointment and bailout as in Edison and Education Alternatives, Inc. I realize that Supplemental Educational Services provider Platform Learning is not publicly traded, but it's not a vast stretch to argue that the folks who decided to put money there and in its competitors fall within the same general class of investment experts represented at the Signal Hill session. Indeed, firms like your own serve as a bridge between the two kinds of investors.

Finally, if there are areas where you think I've sold Wall Street short in the past, I'd like to know about them. You have the opportunity to make your case and ought to go ahead.

I would be very happy for concrete evidence or plausible arguments that things have changed or are not as bad as I think.

[For those reading this exchange who may be new to edbizbuzz: I did run a $15 million fund investing in k-12 through equity and debt - some examples would be Co-NECT (sold to Pearson), TeachFirst, and Voices (sold to Zaner Bloser), I came within hours of investing in LearnNow (sold to Edison) - and am not entirely naive about investment calculations, risk management, what goes on inside these firms, within their boards, and between them and their investors. The Education Entrepreneurs Fund was small and very high risk, but the issues around a $3 million investment are just different from tens of millions in scale. And for a small fund, a three million dollar investment gets a lot of attention from its investment committee. I had an investment committee that included David Kearns, John Ong and John Clendining - former CEOs of fairly significant public firms. So I'm not your average eduwonk.]

From Trace Urdan via November 30 email:

Dean --

I wasn't in the private rooms that day as I was on stage all day but I know that generally speaking holders are not afraid to remove the gloves when necessary. There is always a delicate balance of course as if you want to meet with management a second and third time you cannot alienate them completely. I have attached a note I wrote prior to the conference with questions that I consider respectfully phrased but perfectly to the point....

[edbizbuzz readers please note: Below is an example of questions for one of the firms presenting at the conference drawn from those notes - I've edited out the questions that don't speak to my questions of Trace to focus on the ones that make his point:

2. Do you feel as though there is a limited window to your market opportunity? That if you don't satisfy the demand, other products will move into the void?

3. Are the larger publishers cognizant of the... research on which your product is based and have they made any movement to emulate some of its basic principals?

7. How dependent are you on the tough accountability pro vision in No Child Left Behind? If the law becomes watered down, will any of the urgency leave your market? Are any buyers holding back, waiting to see how the law shakes out?

10. What does the R&D road map look like going forward?

edbizbuzz readers please note: These questions may or may not have been asked, but it's clear that some of my issues were on the writer's mind.]

As for the efficacy issue, yes I was thinking of this last secondary round for Scientific Learning where that dichotomy between strong product and weak results describes the investors' mindset perfectly. I would say Voyager is a different example where early promise fueled the stock and then fears that deals had been more political than substantive caused results and the stock to peter out. I guess I would say that judging the product effectiveness of K-12 supplementals is an extremely difficult process at best where no definitive measures have emerged. The same can be said of charters and charters run by EMOs. Very few "stars" have emerged that I can think of based on classroom effectiveness alone.

Broadly speaking though I look at the demise of Renaissance, Plato, WRC and others, and the relative success of Read 180 and Scientific Learning and to some mixed extent Voyager and I see signs that cronyism is gradually giving way to informed judgment about whether the product is going to make a difference in AYP.

The broad comment I suppose is that I fundamentally don't agree with your points about the simplicity of investors or their conferences. No one makes an investment decision on the basis of a "dog and pony" and I believe you give your readers an incorrect impression about what goes on at the conferences and how public equity investors make decisions and run their business. I also happen to take offense at your characterization of my own peers knowledge of the industry as being inferior to those of analysts in other fields. Would I happily have spent another hour on the K-12 panel delving much deeper? Of course. But that goes far beyond what any public market investors want or need to know at this point. A year from now if K12 is public there will be appetite for more. But I think we at least alerted investors to some of the right questions to ask the K12 management team. It absolutely could have been better but this is an imperfect process when you invite company executives to give up their own time and pay their own way to come and present.

I think our different opinions are informed by our different perspectives and different audiences but I'm just not sure those opinions are likely to converge any time soon. You're welcome to quote from (or paraphrase) this email but I am going to refrain from any further rounds in your blog.

Thanks for the input.

Best, Trace

Comments are now closed for this post.

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