Tuesday, September 17, 2013

My Presentation on K-12

This afternoon at the Value Investing Congress (the investment conference I co-founded) I presented the attached presentation entitled: “An Analysis of K12 (LRN) and Why It Is My Largest Short Position”.

(If you’re interested in investing, the next Congress will be in Las Vegas on April 3-4, 2014 (with my Pre-Congress Workshop on April 2nd). Look here for more info and if want to attend, let me know and I’ll send you our best discount code.)

I know the company and the space well (K12’s primary business is running online charter schools in 33 states and DC), and it’s a VERY high conviction short (meaning the funds I manage will profit if the stock price declines). I think that the company has run amok in many, many ways, inappropriately targeting the most at-risk students, with dismal academic results, off-the-charts student turnover, coming under increasing scrutiny. K12 reminds me of the subprime mortgage lenders and for-profit colleges when they were flying high – and the ending will be similar I believe.

Here’s the summary of why I’m short K12’s stock (page 8 of my presentation):

  •  K12's aggressive student recruitment has led to dismal academic results by students and sky-high dropout rates, in some cases more than 50% annually
    • I wouldn't be short K12 if it were carefully targeting students who were likely to benefit from its schools – typically those who have a high degree of self-motivation and strong parental commitment
      • But K12 is instead doing the opposite; numerous former employees say that K12 accepts any student and actually targets at-risk students, who are least likely to succeed at an online school
      • One former employee said: "K12's recruitment of inner-city and at-risk "last resort" students had another benefit – these students used up less of K12's educational and teaching resources while permitting K12 to collect full funding from the states."
    • Like subprime lending and for-profit colleges, the business makes sense on a small scale but, fueled by lax regulation and easy government money, the sector has run amok
  • There have been so many regulatory issues and accusations of malfeasance that I'm convinced the problems are endemic
    • Enrollment violations, uncertified teachers, conflicted relationships with nonprofit charter holders
  •  I have been looking for years and have not found a single K12 school that is free of scandal and posting even decent (much less good) academic results
  • States (and the IRS) are waking up to what K12 is doing and the company is coming under increased scrutiny, which is beginning to impair K12's growth – and I believe this trend will accelerate
  • Yet the stock, trading at nearly 50x trailing earnings, is priced as if K12 will continue to grow at high rates for the foreseeable future and also improve on its persistently low margins and free cash flow
And lest anyone think I’m opposed to for-profit or inline schools, I write (page 9):
  •  I think an online school can be a great option for some students and families, but an inappropriate and harmful option for others
  •  I am a champion of high-quality charter schools (including online and/or for-profit ones), but I think that low-quality charter schools give the movement a black eye
  • To be clear: I am not bearish on K12 because I am short the stock. Rather, I am short the stock because I am bearish on K12

It’s important to keep in mind that K12 is not at all representative of the charter sector. Approximately 70% of charter schools are nonprofit and K-12’s 117,563 students are only 5.2% of all charter students nationwide.

If you have had any dealings with K12, positive or negative, I’d love to hear about them!

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