Why Investor Whitney Tilson Is Betting Against K12
When the profit motive forces action
Nothing should unite both critics and fans of education technology more than reports of companies making big money from shoddy products. But what about when the critic may also make a profit by betting that a company will tank because of its lackluster service and results?
At the Value Investing Congress in New York City on September 17, hedge fund manager Whitney Tilson of Kase Capital delivered a whammy of a case against online school provider, K12 Inc., with a 110-slide talk on "An Analysis of K12 (LRN) and Why It Is My Largest Short Position," shared on Business Insider. He said that K12 is his portfolio’s biggest short position.
Tilson is a staunch and outspoken fan of education reform. He blogs regularly on education reform and circulates weekly newsletters championing charter schools, reform and edtech in general. He joined Teach for America in its early days and serves on the board of KIPP. And he invests.
At last week’s meeting, Tilson argued that K12 Inc., the largest online K-12 education provider in the U.S., and manager of online charter schools in 33 states and D.C., is due for a fall. Although the company’s stock (ticker: LRN) has risen 70% since January 2012, Tilson says it’s “absurdly overvalued and sure to collapse.”
Tilson’s analysis of why K12 is a poor investment briefly describes its financial numbers, then dives deeply into why it’s failing to deliver education value.
On the numbers (slides 11-19): K12 says its revenue has grown 32% annually over the past decade and that projected earnings per share is expected to climb 32% over the next 12 months. Smoke and mirrors, contends Tilson. He notes that although net income and EBITDA (earnings before interest, taxes, depreciation and amortization) have climbed over the past two years, revenue growth is slowing. Profit margins (over the past two years) have been erratic. And other indicators--how long it takes K12 to get paid, its aggressive accounting practices, and so on--make Tilson jittery.
Even more ominous are Tilson’s concerns about K12’s practices. Among them: (slide 8):
"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 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."
Through personal interviews, analysis of a class action suit and media coverage, Tilson has compiled a lengthy indictment of the quality of K12's service. He recounts stories from former employees (slides 21-25) who say the company follows a "growth-at-any-cost mentality" and "increasingly target[s] at-risk students that it knows are likely to fail." He has strong reservations against K12's publicized academic "successes" after poor results and "sky-high" dropout rates at its schools in Colorado, Pennsylvania and Tennessee (slides 33-59). These issues, along with other regulatory infractions, place K12 under intense scrutiny from state officials. Tilson notes that the company will not be opening schools in any new states next year (slide 81).
Following his presentation, Tilson wrote in an email that "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."
Interesting enough, Tilson shorted K12 in 2012. Others raised questions then, too. The New York Times began writing tough pieces about the company in 2011. (This piece, for instance, begins with: “By almost every educational measure, the Agora Cyber Charter School is failing.”) Reform critic Diane Ravitch has spoken out on K12 for more than a year (likely much longer). Class action lawsuits against K12 were also initiated a year ago.
In a January 4, 2012 blog post, Tilson described himself as “conflicted” about online learning. He wrote: “I have no doubt that online learning can work very well for some kids and, even if it doesn't work great, may well be the least-bad option for many other kids. I also tend to like anything that creates options for parents and competition for the status quo. Finally, I have no problem with for-profit schools. All that said, I have GRAVE reservations about the sector as it's currently operating right now.”
In April 2013, Tilson told investors that he had indeed shorted the stock--but that it had appreciated 18% during the quarter. He wrote: “I remain highly confident that every one of our short positions is vastly overvalued and there are catalysts that will cause the stocks to tumble, but over a short period when the market is ripping upward and complacency abounds, our short book is going to be a headwind.”
The stock kept gaining. Following Tilson’s talk on Tuesday, however, K12’s stock did indeed fall, ending the week at $32.96, down 9.6% from its Monday open.
Perhaps this is a win-win situation for Tilson. By excoriating K12, he will make money in the near future--and perhaps help force it to deliver better services in the long run.