Archipelago Learning's IPO Valuation Favors K12

Archipelago goes public on Thursday. The company intends to raise $100 Million, with shares coming approximately one-half from the company and the remainder from selling private equity companies. At the mid point of the anticipated offering, ARCL will be valued at $400 Million.

Providence Equity Partners bought the company in January, 2007 for approximately $85 million and owns 77 percent. Founded in 2000, the company had sales of $42 Million over the past 12 months. Earnings for the nine months ended September 30 were $6.9 Million while the net profit for the prior year was $1 million. ARCL has been growing their student enrollment and has recently enterd the high school market. Their business is basically internet based test preparation.

At $42 Million of revenue, and a market capitaization of $400 Million, the company is being valued at 10 times sales! The P/E of last year's earnings is 400! Interim results are up considerably, however I haven't delved into the makeup of the improved earnings.

K12 is a similar internet based marketer of lessons and test prep. Its market cap is a mere $550 Million and has trailing 12 month revenue of $330 Million or a P/S of 1.6, not 10. LRN trades at a forward P/E of 24, high but not the 400 or 40, depending on the time period, of ARCL. Both feature the cost savings of the internet, face state education cost pressures, but appear to be able to outgrow the reimbursement reductions. K12 projects earnings growth of 20 percent for 2010.

Today, after the ARCL IPO announcement, K12 increased $.71. I believe it will continue to move upward as investors compare the two companies. An investment in LRN garners a company that has more scale than Archipelago and excellent growth opportunities for a lesser, comparable valuation.

William Kabourek owns shares of K12

K12 Could Become a Shortseller's Nightmare

I've thought that internet learning was destined to be a significant component of educational spending since 2000. That was the year that K12 was founded. That was also the year that I put money into a private placement of Class.com equity. The companies are very similiar as they deliver distance learning content over the internet, except that Class.com limits itself to grades 9-12. The similarity also departs in revenue production as K12 generates sales of $32oMM while Class.com is much smaller. After long gestation periods, both started making money several years ago.

In addition to my stake in the private company, I've put together a position in K12 as well. Like many stocks, it has made a nice recovery from its lows. I think it will continue to do well as it is in the sweetspot of education. It can save school boards brick and mortar expenses, enhance charter school curriculum, and remains popular with home schoolers. It works for remedial as well as advanced placement. Since a teacher is involved, even the teachers unions aren't adamant about killing the process.

With tight school budgets, shortsellers identified LRN as a candidate for decreased funding and resultant revenues. That hasn't happened, but the short interest is still present. And what a presence-it's huge! At mid month, there were over 7.5M shares borrowed and sold short. That is 39% of the float. At present volume levels it would take 63 days to cover those shorts. Take a look at the following table:

K12 Inc ( LRN) Short Interest

LRN K12 IncNYSE Settlement Date Short Interest Avg Daily Share Volume Days To Cover 8/14/2009 7,475,753 118,512 63.080135 7/31/2009 7,482,091 150,145 49.832435 7/15/2009 7,571,249 271,850 27.850833 6/30/2009 6,986,742 628,145 11.122817 6/15/2009 6,619,042 199,696 33.145591 5/29/2009 6,503,427 208,614 31.174451 5/15/2009 6,365,058 316,718 20.096925 4/30/2009 6,225,823 190,804 32.629416 4/15/2009 6,034,347 234,290 25.755888 3/31/2009 5,637,529 314,036 17.951856 3/13/2009 5,073,388 283,731 17.880979 2/27/2009 4,412,162 202,359 21.803636 2/13/2009 4,121,379 197,533 20.864256 1/30/2009 3,936,154 233,823 16.833904 1/15/2009 3,377,937 256,939 13.146844 12/31/2008 3,324,043 194,866 17.058096 Shares short has remained high while volume has lessened. Does that mean that everyone is on vacation? That shares are getting difficult to borrow? That shortsellers are biding their time until after the company reports quarterly results on September 9th? LRN's price has been creeping up which will cause one of two possibilities to happen. Either sellers will renew their attack on the company and be willing to borrow even a greater percentage of the float or decide that revenue isn't crashing and make a move for the exit. If the latter happens, with 63 days to cover, a significant squeeze could occur and the share price could move nicely higher. Would it stay high? It could as a squeeze would attrack notoriety and momentum investors, plus K12 is still growing, a rarity today, and in an insulated space. I'm keeping my position and hope that I see some nervous shortsellers in the next couple of weeks.

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.