Blackboard (BBBB) is part of the educational universe that is typically parsed by market served: K-12, post-secondary, or corporate. These are broad markets that contain within very different business models. Part of our belief at Advisor is that you should care more about specific business models than traditional sectors. Education is a great example of an investment sector that hosts a diverse number of business models. The less desirable models are capital-intensive and people-intensive; such companies are expensive to grow and scale. Post-secondary education, for example, is generally promising because its growth will easily outpace economic averages. But traditional post-secondary companies like Strayer Education (STRA) and Career Education Corp (CECO) are challenged because, historically at least, they have relied heavily -- even if not entirely -- on the acquisition of new schools to create shareholder value.

Blackboard, while technically belonging to the post-secondary category, has a business model that we love. Since our recommendation last year, we have seen almost 70% share appreciation. Normally, when a stock gets all the way to cable television, like Blackboard has, we worry that it's peaked. But right after Jim Cramer "discovered" Blackboard, Wall Street predictably punished the stock when the company notched down its 2006 guidance. Their real sin was guidance that implies revenue growth next year of 15%. That's a deceleration relative to last year's growth rate of 21%. But the pullback means you can still buy into a quality company at roughly a fair price. Subscribers can read our update for the particulars.

In late March, Blackboard will provide more clarity on their approved merger with elearning provider WebCT. It is possible that the street will punish them again because Blackboard has already said the acquisition will be "dilutive to GAAP EPS in 2006 and 2007" but also that it will be "accretive to non-GAAP earnings in 2006 and significantly accretive in 2007." In other words, reported EPS will suffer but cash EPS will grow. You have to scrutinize non-GAAP numbers on a case-by-case basis, and sometimes non-GAAP metrics are promoted by the company but not really key performance metrics. But in Blackboard's case, cash EPS is good number. In fact, Blackboard has consistently done a good job of reporting relevant pro forma numbers and performance metrics. (This is part of parcel of their strong governance and their investor communications savvy). Regardless of the impact on near term EPS, the acquisition looks smart and we are unchanged in our original view that Blackboard's eventual destiny is to become a $1 billion company, at least, in equity market capitalization. The acquisition uses cash such that the transaction, per se, will not create market equity – so I mean that the combined company is well-positioned to organically create another several hundred million in market value.

The acquisition will grow near-term revenues by about 30% but should not really impact Blackboard's long-term revenue growth rate (in the high teens). The companies are similar except that WebCT offers a single course management system and they have better international penetration, for their size. By adding WebCT, Blackboard roughly doubles the number of international clients, to over 1,000.

The immediate benefit is that Blackboard can offer a broader product line to existing WebCT clients (i.e., existing customer overlap is de minimums). They should be able to increase the average contract value of a WebCT client, up from $21,000 to somewhere closer to Blackboard's average contract value of $35,000 per client.


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The merger does not change Blackboard's excellent business model. The company has great visibility into go-forward financials because at least 90% of their clients renew each year (92% in the last quarter). On top of this strong base of recurring revenue, Blackboard can up-sell clients from the basic to the enterprise version (they up-sell at least 10% of the basic clients annually). Further, whereas many application service provider (ASP) models are dubious, several of Blackboard clients will have good reason to ask the company to host these large-scale, campus-wide platforms (unlike many applications that only require bandwith and connectivity, learning management systems generally need more robust support).

Add to this recurring revenue model a few absolutely delightful "real options" on future growth. These are innovative segments that, while they may not contribute greatly to current revenues, hold remarkable future potential. There are at least two in Blackboard's case, aside from the ASP segment. First, the company works with educational publishers to provide titles in digital format (and compatible with the Blackboard platform). Blackboard collects a small license fee for every student per semester (about $2). With almost 5,000 titles, they are growing this business by about 30% per year.

They also offer BbOne, a cashless transaction system that allows Blackboard to collect transaction fees similar to the way that Visa and Mastercard do. Since they already have portal status with teachers and students, this is natural extension.

The other smart move by Blackboard is their embrace of open source. The company deployed Building Blocks, which is simply a repository of third-party developer extensions. (This is possible because the company makes publicly available certain elements of the platform). Smart software-related companies embrace open source because they extend their reach; customers often add the most popular new features without any central planning from the company!

Blackboard's management might be relatively young, but they continue to offer a case study in good governance and good business models.

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