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Why K-12 Education Is Rosetta Stone's Next Big Growth Opportunity

By Luis Sanchez CFA - Apr 10, 2019 at 9:33AM

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The company's push to sell educational software to schools has given investors several reasons to be bullish.

Rosetta Stone (RST) is well known for its foreign-language programs, but that business is a shadow of its former self after losing market share to app-based competitors. The company has shifted gears and is now focused on a business that brings software-based education to K-12 schools.

Will this strategic pivot yield positive results?

A shrinking legacy business

Rosetta Stone Business Segments 2013 Revenue 2018 Revenue
Consumer foreign language $204 million $60 million
Corporate foreign language $60 million $60 million
K-12 literacy N/A $53 million

Data source: Rosetta Stone financial reports.

Foreign-language education has been the hallmark of Rosetta Stone's business, but the market has changed significantly over the past 10 years. The proliferation of smartphone apps has accompanied a major decline of Rosetta Stone's foreign-language revenue.

As a result, the company has moved toward K-12 literacy education.

Building a K-12 education product

Rosetta Stone entered the K-12 education market when it acquired literacy-education company Lexia Learning Systems in 2013. Literacy education is similar to foreign-language education, enabling Rosetta Stone to capitalize on the expertise it developed from prior years.

When Rosetta Stone acquired Lexia, its literacy software only served students from pre-K to fifth grade. Rosetta expanded the product to cover more grade levels. The company also developed enhanced software tools for teachers to track student progress.

The revamped software suite is more marketable to school districts, because it's a total solution. It has also received industry praise. THE Journal, an education industry publication, recently ranked Rosetta Stone's literacy education product No. 1, beating out competing solutions from Apple and Google.

Children in a classroom, with the Rosetta Stone logo in the upper-left corner.

Image source: Rosetta Stone.

K-12 products require a new business strategy

Although the product side of the business is similar, the sales strategy for K-12 education is totally different. Instead of selling packaged software through direct-to-consumer channels and retail stores, Rosetta Stone has had to develop a sales force to call upon school districts and bid for contracts.

It would have been difficult to build a K-12 education business organically, but the Lexia acquisition gave Rosetta a beachhead into school districts with several preexisting contracts. From there, the company has built a sales team of 75 people to win new deals. 

Once awarded, contracts are multiyear sources of recurring revenue. From a business standpoint, recurring revenue is preferable, because it's more predictable. This is in contrast to Rosetta Stone's foreign-language CD business, in which it made one-time sales to consumers.

The process for selling software to schools is arduous with just a limited number of contracts, and school districts are less likely to take a chance on a new company without a proven track record of success. This is actually a good thing for Rosetta Stone, because it creates a barrier to entry for new competition -- preventing a repeat of what happened to its foreign language business.

The K-12 growth opportunity

There is growing interest from parents and schools in using technology to improve educational outcomes. Literacy is a great opportunity for the company, because it impacts every student, many of whom are falling behind. For example, according to Rosetta Stone, 64% of fourth graders are nonproficient readers.

In 2018, Rosetta Stone's K-12 business served four million students in 17,000 schools, but this is just a small fraction of the overall market. There are more than 47 million K-12 students in the United States at approximately 103,000 schools -- Rosetta Stone is capturing less than 20% of the current market. With a product ranked No. 1 by industry publications, the company is well-positioned to win a place in more classrooms.

There's also the opportunity to increase revenue per school through upselling. Rosetta Stone is developing a product for foreign language-speaking English learners and is adapting its foreign-language programs for school curricula. The company already has a strong brand in language education it can leverage.

In the fourth quarter of 2018, Rosetta Stone grew revenue in its K-12 business by 20% year over year. Investors can expect this high rate of growth to continue based on these opportunities to increase market penetration and cross-sell programs.

Foreign-language books clamped between a pair of headphones and resting on a world map, with a notebook and pen beside them.

Image Source: Getty Images.

A reenergized company

Rosetta Stone has long been overlooked by investors as it struggled with industry disruption. However, the K-12 education business is a promising growth opportunity that has injected new hope into the stock. What's more, this segment has the markings of a higher-quality business with predictable revenue streams and stronger barriers to entry. Rosetta Stone investors have good reason to be optimistic.

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