Monday, February 16, 2009

Growth is Safety in 2009

I spend a lot of time attempting to find opportunities to invest safely. It hasn't been easy or productive. Many of my great ideas are worth less money today than when they were conceived. But I don't give up.

The landscape is fraught with time bombs. Financial firms are de-leveraging, consumers have discovered thrift, retailers are caught without demand, manufacturers have seen exports crater, and the auto industry is near collapse without a bailout. Consumer staples companies are seeing customers trade down to store brands. Energy and agricultural companies have seen their pricing power lessen. Recreation and travel are hurting and even casino gaming is contracting. I've depressed myself again.

The only sectors that look promising are healthcare technology and for profit education. I haven't sifted through all the healthcare information technology companies yet so I don't have any brilliant ideas in that area. The for profit education area, an area that generally serves post high school students, has been an investor favorite and will probably continue to attract followers as a safety investment. I'm not fond of those companies due to their dependence on federal student loans, expensive tuition, and dubious value. But they've made lots of money, have little debt, and will benefit from Obama's stimulus spending on Pell Grants and student loan funding. They are so popular that they will make a better short play some day in the next year or two.

There is a public, for profit education company that I do like conceptually. The online, virtual school industry is growing at a fast pace. These companies, mostly private and some quite large, sell online courses to school districts, private schools, home school parents, and corporations. Their business plans depend on school funding not student loan funding. Obama will benefit this group as well.

In 2000 I invested in a company that was in the vanguard of high school internet education. Investing in that private placement has not built my net worth. For years they chewed up capital, with plenty of dilution, developing and enhancing coursework. Earnings were nonexistent. However, the last two years have been nicely profitable. There is a market for their products and they are projecting a very good 2009. That company is a miniature K12 [LRN].

K12 is not a cheap Ben Graham type investment. In fact it is rather expensive. In 2009 I believe their is better upside potential in an expensive stock that can still show growth vs. a low book value company that is experiencing volume and earning declines. The market will pile into those companies that can show growth while the majority of companies contract. Growth will command a premium. Growth will be the year's safety play.

LRN has a market capitalization of $530MM and has been as high as $30 during the past 12 months. It sells for 3XBV and 14XEV/EBITDA, two very rich valuations. But it also produced revenue growth of 43% quarter over quarter and 68% growth in EBITDA. Their platform of internet courses is highly scalable and the growth numbers are starting to show why the shares may not prove to be rich for long. While the valuation is rich today, you at least get a good balance sheet. They have $50MM of cash, virtually no debt, and still have a loss carryforward of $64MM. They aren't dependent on lenders; a plus in this credit crunch.

As I've opined before, it's difficult to buy a stock in this environment, but I like the odds of putting some money into K12. LRN has a good opportunity to continue growing as they are in a growth area with expanding funding. The market should pay for this safety play.

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