Before we jump into today's column, we'd like to acknowledge the big news yesterday in Rule Breaker holding Excite@Home (Nasdaq: ATHM). George Bell, who ran Excite before it merged with @Home, resigned as CEO, though he will remain as Chairman until the end of 2001. We have written several times recently about the company's lack of direction, especially in its media segment. Bell's resignation didn't inspire the market's confidence that the situation would improve -- the stock fell 7% by midday today. See TMF Nico's article on Excite@Home in today's Fool News. Now, on to our regularly scheduled topic...
It being mid-September of a year divisible by four, there's a bit more talk in the air about our nation's educational system than usual. You can check out the Gore website or the Bush website for the two major party candidates' proposals on what to do about the education system. Regardless of who wins, one trend that seems likely to continue is the growth of private companies in the management of public and charter schools.
One company capitalizing on the nationwide dissatisfaction with the status quo is my younger sister's employer, Edison Schools (Nasdaq: EDSN). Founded in 1992 by Christopher Whittle, Edison is the leading private manager of public schools. After putting three years of research into creating a unique curriculum, Edison took over the management of four existing public schools on a contract basis in 1995, and roughly doubled its school base annually through 1999. The growth rate at this point, off a much higher base, has slowed to about 50% annually. This coming year, Edison will be running 108 schools, with roughly 57,000 to 59,000 students enrolled -- roughly the size of a major American city's school system.
A look at Edison's annual revenues gives some idea of the scale of growth achieved so far (fiscal year ends in June, figures in millions):
1995: 0.0
1996: 11.8
1997: 38.6
1998: 69.4
1999: 132.8
2000: 224.6
2001E: 340.0
There's customer satisfaction here, as Edison can point to some positive general test score improvements in the schools it has been running for a few years (the American Federation of Teachers disputes Edison's results), and Edison has been able to renew contracts with all of its original schools.
Still, Edison hasn't exactly been translating that phenomenal top-line growth into earnings yet. Looking over the historical net loss from operations is likely to give pause to even the staunchest Edison supporter (figures in millions):
1995 -$14.3
1996 -$10.0
1997 -$11.4
1998 -$20.9
1999 -$49.3
2000 -$37.9
While the losses are, in part, explained by Edison's investing for future expansion, the six-year figures raise the question of when Edison will have built up enough mass to realize any economies of scale. Edison has no real pricing power -- it receives no more in revenues for managing a school than the public school system would otherwise have spent to run the school itself. Since Edison's plan calls for both a longer school day and school year than the normal public school schedule (adding up to a roughly 50% increase in hours per year than the norm), it won't be all that easy to produce a profit.
Though there are some legendary inefficiencies in public school administration, any efficiencies that Edison might provide are currently thwarted by operating a school system spread throughout 20 states, and expanding each year. Edison will have to get much, much bigger to enjoy true economies of scale.
Profits aren't there yet, and they don't appear to be coming in the near future. However, as regular readers of this column know, lack of current profits isn't a bar to qualifying as a Rule Breaker. Let's take a "Break Down" look at what the portfolio methodology indicates regarding Edison's potential.
- The top dog and first-mover in an important, emerging industry...
- Sustainable advantage gained through business momentum, patents, visionary leadership, and/or inept competition...
- Excellent past share appreciation, measured by a relative strength of 90 or higher...
Edison has a three-month relative strength of 93, and an 11-month relative strength of 87. Part of that relative strength, however, comes from the fact that Edison, which came public in November 1999 at $18 a share, quickly fell below its IPO price and was available for about $12 a share six months ago. - Good management and smart backing...
- The greater the consumer brand, the better...
- A significant constituent of the financial media is recently on record for calling it overvalued...
Edison is the largest private manager of public and charter schools by severalfold over its closest competitor, and thus qualifies as a top dog/first-mover in the industry of public school management. Whether this industry is "emerging" in a way that's attractive to Rule Breaker investors depends heavily on whether you define the industry as "schools" in general, or "private management of public and charter schools." I could go either way on that, but I think Edison passes the spirit of the test.
Edison appears to have a sustainable advantage stemming from the substantial millions invested in creating its unique curriculum -- a curriculum that appears to be paying off in the form of statistically significant standardized test score improvement. According to Edison press releases, there is a waiting list of approximately 10,000 students who want to be enrolled in Edison schools.
CEO Whittle can legitimately claim to have vision, and the competition for Edison -- the nation's many local and regional public school systems -- while not "inept," have significant limitations in ever achieving true economic efficiency because of the inherently limited size of any locally controlled school system.
Edison has business momentum. Edison recently announced a plan in conjunction with the local teachers' union to build and manage 10 new schools in Miami-Dade County, and has a proposal in to manage up to 45 New York City public schools.
On the heels of several announcements of new school openings for next year, as well as some transparent sales pushes from the "analysts" at Edison's investment bankers Merrill Lynch and Bank of America, the share price has since recovered and now stands well above the IPO price.
Hard to say. Founder and President/CEO Chris Whittle has a checkered past regarding companies he's managed, with Channel One in particular being less than a success. Chairman Benno Schmidt was the president of Yale (my president, in fact) prior to joining Edison. Beyond his dalliance with the Ivy League, though, Schmidt is perhaps best known for being the only president of a publicly traded company to appear in two Woody Allen movies. (I confess that I have not exhaustively researched whether he is the only one, though it appears kind of likely.)
Regarding backing, among the early investors in Edison is second-richest guy in the world, Paul Allen.
Pretty tough to assert that Edison has a strong consumer brand, though in the sense that there are waiting lists to get into the Edison schools, you could argue otherwise.
Prior to its IPO, well-known columnist Christopher Byron wrote a humorous and monumentally unbalanced screed about Edison entitled "Whittle and Benno Schmidt Try Another IPO Fast One." In between dozens of ad hominem jibes (Byron appeared intent on setting the non-discussion-board record for the highest insults-to-analysis ratio), the article essentially concluded Edison would be overvalued at any price.
At least until Edison comes closer to proving it has unlocked the key to making money off its impressive growth, despite its various qualifications as a Rule Breaker, I am inclined to take a wait-and-see attitude. Let's have your take on the Rule Breaker Companies discussion board.
--Bill Barker, TMF Max on the discussion boards.
