These are grim days for the for-profit education sector. The government has painted a bullseye on the hind ends of companies like Apollo Group (Nasdaq: APOL), DeVry (NYSE: DV) and Career Education (Nasdaq: CECO), ostensibly for poor student loan repayment rates and generally over-promising the benefits of post-secondary education (though many public/private universities have similar problems...).
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Investors may want to broaden their horizons and take a look at Archipelago Learning (Nasdaq: ARCL). Although sometimes grouped in with those for-profit educators, Archipelago's business model is completely different, and comparing this company to that industry just makes no sense. Archipelago is in the business of selling online subscription-based educational content to K-12 schools, helping those schools educate their students better and achieve higher test scores.
A Quarter Worth Studying
For the third quarter, Archipelago reported a 46% jump in revenue to just over $15 million, so this is very clearly still a very small company. Scrubbing out the boost provided by the mid-summer acquisition of Education City, growth was more on the order of 27%. Going a step further, the company also reports invoiced sales; this is not at all uncommon with subscription-based models where there is a time gap between recognizing a "sale" and getting the money. By this metric, sales were up 37% for the quarter and 19% ex-Education City. (For more, see Pay Back Time In For-Profit Education.)
While the top line is at the head of the class, the dog must have eaten some of the company's profit leverage. Gross margin was an eye-popping 90%, but that was still down from 93% in the year-ago period. Elsewhere, higher staffing costs and expenses from the merger and IPO both pressured income, and operating income dropped almost by half. Some of these expenses are "growing pains" for a small company like Archipelago, and by the company's self-reported (and decidedly non-GAAP) adjusted EBITDA breakdown, underlying profitability was up 23% by at least that measure.
The Road Ahead
As the revenue line clearly indicates, Archipelago is a small company. Still, it has served more than 12,000 schools and 9 million students, so it is not exactly trivial either. Given that there are over 95,000 public schools in the U.S. alone (and this company also targets the U.K. and Canada), there is a huge opportunity in front of the company. Keep in mind, though, that this opportunity is not lost on McGraw-Hill (NYSE: MHP), Houghton Mifflin Harcourt, Pearson (NYSE: PSO) or Washington Post's (NYSE: WPO) Kaplan - all of which are looking to online education as a way to expand their businesses in textbooks and supplemental education services.
Archipelago's offerings seem affordable (about $2 to $10 per student per subject) and are adjusted on the basis of the specific school, state and breadth of content. What's more, some small studies point to meaningful improvements in test scores for students who use this company's content. If the company can maintain this performance and demonstrate that it offers an affordable way to improve learning outcomes, school boards will almost certainly take note. Investors should also realize, though, that in the world of conflicting standards, budget pressures and conflicting agendas that surround public education in the U.S., what makes sense and what is best for the kids does not always happen.
The Bottom Line
Archipelago has eye-popping valuation in terms of enterprise multiple, price-to-sales and the like. On a discounted cash flow basis, though, the valuation looks much more like a bargain. This is a highly scalable and leveragable business model, meaning that there is little incremental cost in expanding the revenue base. If the company can continue to grow revenue percentage even just in the teens, investors could find a real bargain here.
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