Offering money-saving solutions for K-12 education is usually a pretty good business plan, but perhaps not so much in those times where state budgets and standards are in flux. While Archipelago Learning (Nasdaq:ARCL) offers attractive cloud-based supplemental education products, the company is seeing business slow a bit, due to those macro factors. While this company certainly carries above-average risk, it also offers above-average potential for risk-tolerant growth investors.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

Still Growing, But...
The recent issue with Archipelago isn't that it's no longer growing, but that its growth rate has declined recently. While the company was posting 30%+ year-on-year growth rates early in 2011, that growth has declined to the point where sell-side analysts expect only single-digit growth for the fourth quarter (to be reported in March).

There is relatively little evidence that this is a byproduct of more intense or effective competition from the likes of Pearson (NYSE:PSO), Houghton Mifflin or Reed Elsevier (NYSE:RUK). Instead, there is ample evidence that severe state education budget issues around the country are having a role. When classroom spending is being rolled back and teachers are being laid off, even a money-saving tool like Archipelago's Study Island may not get much consideration. (For related reading, see How Education And Training Affect The Economy.)

Penetration Improving, Now for the Follow-Ons
Although Archipelago is seeing challenges from budget pressures and changes in the standards in Texas, other large markets like California and Florida have been relatively healthy. Overall, the company has pushed its penetration to nearly one-third of the domestic K-12 market, and the company continues to develop and launch new follow-on products for areas like test prep, ESL and remediation.

It seems as though budget pressures have closed some minds in school systems with respect to new initiatives, but Archipelago still has a lot to offer from a long-term perspective. With incremental per-student, per-subject costs of less than $10, there's definitely an argument to be made that Archipelago is a money-saving tool for school systems that are under pressure to do more with less money. Although Archipelago isn't supposed to serve as a substitute or replacement for direct classroom education, the reality is that this may start happening to some extent, as there simply isn't the manpower or resources to go around.

Undervalued
There are risks and issues with the Archipelago business model. The problem with cloud-based subscription models like Archipelago's is that they're easy to get into and relatively easy to get out of. That's arguably more of a risk for smaller companies like Archipelago, Cambium (Nasdaq:ABCD) and Learning Tree (Nasdaq:LTRE), as opposed to the major multimedia publishers that can arguably fall back on bundling and integrated products (integrating text books with online services).

There are also issues with Archipelago's accounting. This is no way an accusation that ARCL is doing anything wrong; simply an acknowledgment that subscription models demand a different accounting treatment and that can create confusion and false controversy with some investors.

Certainly something seems to be weighing on these shares. Relative to deals involving Renaissance Learning, Pearson and Blackboard (which was bought by the same entity, Providence Equity, which owns a large stake in Archipelago), Archipelago is undervalued.

The stock also looks too cheap on a cash flow basis. While a decade of free cash flow compound growth of 9% may not sound especially conservative, I would argue that it is with Archipelago, considering the opportunity to add more school systems to the client list, the prospect of selling more services to existing customers, and continuing expansion in English-speaking markets like Canada and the U.K. (For related reading, see Free Cash Flow: Free, But Not Always Easy.)

With prospective fair value in the low-to-mid teens, Archipelago is a name worth considering, while state budget issues have cast clouds over the true long-term growth potential of the company.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  2. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  3. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  4. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  5. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  6. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  7. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
  8. Investing News

    A 2016 Outlook: What January 2009 Can Teach Us

    January 2009 and January 2016 were similar from an investment standpoint, but from a forward-looking perspective, they were very different.
  9. Mutual Funds & ETFs

    3 Vanguard Equity Fund Underperformers

    Discover three funds from Vanguard Group that consistently underperform their indexes. Learn how consistent most Vanguard low-fee funds are at matching their indexes.
  10. Investing News

    Alphabet Earnings Beat Expectations (GOOGL, AAPL)

    Alphabet's earnings crush analysts' expectations; now bigger than Apple?
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center