Monday, February 27, 2012
Why Publicly Traded Education Companies Barely Exist...
There's a risk to taking education to Wall Street, one that explains why so few publicly traded companies cater to public schools. Read on...
K12 Inc., the nation's largest provider of online precollegiate education, was launched in 2000 and went public seven years later after raising about $140 million in revenue. Like other companies, it moved from being privately held to being publicly traded to raise more money quickly, increase brand awareness, and accelerate business goals.
The company now works with more than 2,000 U.S. school districts and reported $522.4 million in revenue last fiscal year. "No school district could ever invest what we do and get the productivity we get," said Chief Executive Officer Ronald J. Packard. He said his company invests about $40 million a year in new technology and programs.
But there's a risk to taking education to Wall Street—one that helps explain why so few publicly traded companies cater to the educational needs of students in elementary, middle, and high school.
K12's stock prices plummeted after a Dec. 12 article in The New York Times accused the Herndon, Va.-based company of wresting profits from public school dollars by increasing enrollment without concern for student retention, assigning teachers to unmanageably large classes, and lowering standards.
The article also reported that Mr. Packard's $5 million salary in fiscal 2011 was nearly twice the previous year's $2.67 million, and that his annual bonus is partially linked to enrollment. Shares fell from $28.79 the day the story ran to $17.25 three weeks later on the New York Stock Exchange.
Then, on Jan. 31, a lawsuit was filed by a K12 Inc. shareholder against the company and some of its senior executives, alleging it had violated securities law by making false and misleading statements to investors. ("K12 Inc.'s Public Status and Growth Attract Scrutiny," this issue.)
"There are so many strings that come with being a public company," said Steve Pines, the executive director of the Education Industry Association, a nonprofit organization based in Vienna, Va., that helps education entrepreneurs connect with the K-12 market. "It's not for the fainthearted."
Beyond having to deal with a level of transparency that privately held companies are generally protected from, publicly traded companies offering K-12 instructional services face other potential complications.
They have a poor track record, for starters. Edison Schools Inc., now EdisonLearning Inc., a former leader in for-profit schooling, is the most prominent example, with analysts using its heyday and subsequent troubles as an object lesson in what not to do as a public company. New York City-based Edison reported only one profitable quarter over the four years it was publicly traded, failed to deliver on its promises of academic improvement, and lost contracts with school districts across the country.
And it's expensive to comply with multiple and extensive reporting requirements from the U.S. Securities and Exchange Commission, including the Sarbanes-Oxley Act of 2002, which Mr. Pines called "an audit on steroids."
What's more, the scrutiny is intensified when the educational best interests of children are put on a profit-loss spectrum. The tension leads one academic observer to label the act of gratifying shareholders while providing superior education "an inherent clash of cultures."
Those two goals are at odds with each other, said Alex Molnar, a research professor at the University of Colorado at Boulder's school of education. He used an example of a company that moves a factory to Mexico to double profits to 12 percent.
"The move will be socially destructive by killing pensions, eliminating health care, and destroying jobs, but the shareholders will get an extra 6 percent—and that's the sort of environment we're headed toward in public education," Mr. Molnar said. "It's not illegal, but it's not serving the public very well."
Regardless of the current debate over the profit motive in education, the stock market can pump a lot of money into companies targeting the K-12 instructional market. And if a company's goal is to grow big, venture capitalists can only take it so far, observers say.
"If you want to get your hands on $500 million, it's hard to do that privately," said Frederick M. Hess, a resident scholar and director of education policy studies at the American Enterprise Institute, a free-market-oriented think tank in Washington.
"If you're a relatively small company grossing $30 million a year, and your capital requirements are $5 million, you could certainly get that from one angel investor and avoid the whole headache of going public," said Mr. Hess, who also writes a blog for edweek.org. "But in most of the world, the goal is to go public because that's where the founders can grow a really thriving enterprise."
Mr. Hess doesn't see why there have to be winners and losers when education companies go public: "It's a business proposition. They're offering a service and trying to get paid for it. Contracting for services can be a perfectly healthy solution, and I'm always interested in why we try to make it such a moral issue," he said.
Publicly traded education companies point out that school districts have outsourced services for decades—for construction, transportation, meals, and staff training, for example—and argue that if they didn't deliver on their promises, they would stop growing and eventually go out of business.
The long-term impact of unwelcome attention on K12 Inc., meanwhile, is uncertain.
According to Mr. Packard, the New York Times article was an "unfair and erroneous attack" that ultimately strengthened the resolve of K12's employees and proved that its long-term core investors truly backed the company's mission.
The stock slump didn't last long. Prices began rising again by early January. At press time, K12 stock was trading at $21.89.
K12's financial report for the second quarter of fiscal 2012 showed that while net income was down 46 percent, with higher costs causing profits to fall short of Wall Street predictions, revenues grew to $166.5 million—an increase of $37.5 million, or 29 percent, over the same period the prior year.
"Companies that are great over the long term are companies that worry about their customers, not the stock market," Mr. Packard said in an interview this month. "The stock will eventually take care of itself."
Gary Miron, a professor of education at Western Michigan University and a National Education Policy Center fellow, said he won't be surprised if other companies find themselves in the same situation as K12's, particularly with the industry's high dependence on self-reporting.
"It's like asking Coke or Pepsi which soda is best," he said. "Oversight becomes complicated."
K12 started rebounding quickly, however, and will continue to thrive because it has figured out, in football terms, "an end run," said Samuel E. Abrams, a visiting scholar at Teachers College, Columbia University, who is writing a book on school reform for Harvard University Press.
"It has grown because it can achieve economies of scale, especially as we become more comfortable with online learning and online living in general," Mr. Abrams said. "It's a much more subtle form of educational outsourcing, and as such it doesn't generate the same pushback and distrust" as for-profit management of brick-and-mortar schools.
A 2011 study by the National Education Policy Center deemed virtual schools the fastest-growing segment of alternative education.
In 2010, 48 states and the District of Columbia had virtual school programs, 27 states allowed virtual charter schools, and approximately 1.5 million students took one or more courses online, according to the Evergreen Education Group, a consulting firm in Durango, Colo.
Some companies are going public through mergers and acquisitions, often by selling themselves to larger companies in the educational technology sector.
The textbook-publishing giant Pearson, a publicly traded company based in London, acquired Connections Education, the United States' second-largest online school business, in September from an investor group for $400 million in cash.
Based in Baltimore, Connections had been a stand-alone, privately owned company since 2004. It operates virtual schools or academies in 22 states—with plans to enter Iowa in the fall—and serves about 40,000 students.
With a yearly 30 percent revenue growth, an estimated $190 million in revenue in 2011, and annual surveys consistently showing that 95 percent of families would recommend Connections, the company expects to have an even greater impact in the world of online learning now that it has the benefit of Pearson's global reach. At press time, Pearson's stock was trading at $19.41.
"There was never a timetable set or a path chosen for us to become a public company," said Ted Ochs, the chief operations officer and chief financial officer for Connections Education. "But we've always said that if we serve our students well, we'll figure out the business model to make things work."
Wireless Generation, based in New York City, also appreciates the larger platform it was given after Rupert Murdoch's News Corp. bought a 90 percent share of the educational technology company for $360 million in 2010. (Larry Berger, a co-founder and the CEO of Wireless Generation, is a trustee of Editorial Projects in Education, the nonprofit corporation that publishes Education Week.)
"There was a time when Wireless Generation was trying to get attention for the products and services it was offering, and it was a little hard to do," said Zachary Silverstein, the chief of staff for the company, which says it serves more than 200,000 educators and 3 million students in all 50 states. "Being part of a bigger company presents more of an opportunity to be recognized and to tell the world about what we're bringing to the classroom."
But Wireless Generation could also be tarnished by its association with News Corp., which is best known in the United States for its ownership of right-leaning media outlets and is embroiled in a scandal over its news-gathering practices in Britain. New York state blocked a contract awarded to Wireless Generation in the wake of the News Corp. scandal. ("Scandal Clouds News Corp.'s Move Into Education," Aug. 10 and "Wireless Generation Loses Contract in Wake of News Corp. Scandal," Sept. 14, 2011.)
Meanwhile, some companies, for strategic reasons, bounce back and forth between being publicly traded and privately held. Now a private tutoring company, Baltimore-based Sylvan Learning has done just that since it first went public in 1993.
Sylvan spokeswoman Darshana Patel said via email that the company's "capital-structure decisions are made with two goals in mind—maximizing educational outcomes and shareholder value."
While some economic analysts note it's unlikely many more education companies will go public in the near future, a few trends—such as the increasing emphasis on digital education, as well as global education in emerging markets worldwide—may eventually turn the tide. Large companies pay big prices for acquisitions, in fact, because they anticipate those trends will reap big rewards.
"This usually predicts that smaller companies will resist the temptation of being bought up, and instead get to the scale where they take themselves public," said Susan Wolford, the managing director and head of the business-services and media group at BMO Capital Markets in New York City. "And then, hopefully, off they go."