k12 tilson short

7/29/2019 K12 Tilson Short

http://slidepdf.com/reader/full/k12-tilson-short 1/13

An Analysis of K12 and Why It Is My Largest Short PositionBy Whitney Tilson, Kase Capital, [email protected] Seeking Alpha, 9/22/13http://seekingalpha.com/article/1707192-an-analysis-of-k12-and-why-it-is-my-largest-short-position

Last Tuesday at the Value Investing Congress, I gave a 118-slide presentation (posted here) about my

largest short position, K12 (ticker: LRN). In it, I shared the many reasons why I think the company (andthe entire sector) have run amok and why, at 46x earnings, I think the stock is a fantastic short.

The Bull Case for K12

There are many reasons that explain the bullishness of some investors and nearly all analysts (seven of the eight who follow the stock have a buy or strong buy on it). First, K12 has grown its revenue 32%annually over the past decade, as this chart shows:

Revenue ($M)

And analysts are projecting revenue and EPS growth of 16% and 32%, respectively, over the next 12months, fueled 10 new schools and enrollment cap expansion of 17,000 new seats. And K12 has lessthan $1 billion in revenue in a market that it says could become as large as $15 billion annually.

It’s also important to note that online schools can be an excellent option for certain students – for example, children whose pace is extremely accelerated, entertainers, solo athletes, teenage mothers whoneed to stay home with their babies, victims of bullying, children with cancer, seizure disorders, peanutallergies, etc.

(Note that my critique is of 100% online charter schools, not all for-profit charter schools or blendedlearning schools. The schools I’m talking about are ones in which students are supposedly learning bysitting at home all day in front of a computer, interacting with teachers almost exclusively online.)

K12 has a well-regarded curriculum, reports very high parental and student satisfaction, and has strong political support, especially among Republicans, for giving parents school choice. Finally, it’s operatingin a space, online learning, that has enormous buzz (think MOOCS, etc.).

So what’s not to like? Let me count the ways…

$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

mailto:[email protected]



http://seekingalpha.com/article/1707192-an-analysis-of-k12-and-why-it-is-my-largest-short-position


http://www.tilsonfunds.com/K12-Tilson-9-17-13.pdf








-2-

Weakening Financials and Aggressive AccountingIn my presentation, I show that K12’s profit margins and free cash flows are low and erratic, days salesoutstanding has doubled in the past five years, the company uses aggressive accounting techniques toinflate reported profits, and K12’s founder, Knowledge Universe, distributed its entire stake to itsinvestors only a few weeks ago. But I want to draw particular attention to this chart, which shows thatyear-over-year revenue growth – critical for a stock trading at nearly 50x earnings – has been fallingsharply over the past two years, and is projected to fall further in the next year (to 16%):

Year-Over-Year Revenue Growth

Aggressive Recruitment Leads to Vast Numbers of Students Destined to Fail

While online schools can be an excellent option for certain students, it’s a very small number – typicallythose who have a high degree of self-motivation and strong parental commitment. It’s sort of obvious if you think about it. Do you think you would have learned more during your K-12 educational experienceif you’d sat at home in front of a computer, or gone to school and had daily face-to-face interaction withteachers? How many of today’s youth – in a world filled with 500 TV channels, texting, video games,etc. – do you think are better off at home rather than being at school? Lastly, what do you think theanswer is for the most at-risk kids, who typically come from poor, single-parent households, in whichthe parent has little time or ability to be the “ parent coach” that’s so critical to online education?

Tom Loveless, an education researcher at the Brookings Institution who did paid consulting for K12 inits early years, said: “The enthusiasts for cyber learning have overstated the potential. What they keepforgetting is we’re not talking about college students here. We’re talking about high schoolers andyoung kids. The idea that parents go to work and leave their kids in front of a computer — it’s absurd.”

In short, online schools are only educationally appropriate for a very small number of students, whichmeans that K12 and its peers need to be highly selective in recruiting students, warning parents awaywhose kids are unlikely to succeed at an online school, especially at-risk youth.

So what does K12 do? Exactly the opposite. Since going public in late 2007, numerous former employees have told me that K12 has adopted a growth-at-any cost mentality in order to support itsrichly priced stock. Jeff Shaw, the former Head of School of Ohio Virtual Academy (which todayaccounts for 11% of K12’s revenue), told me:

0%

10%

20%

30%

40%

50%

Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13

http://www.businessweek.com/magazine/content/11_24/b4232076996440.htm#p1






-3-

After the IPO, I got discouraged because the company’s priority seemed to shift from academics togrowth – it wasn’t so much about academic achievement but on delivering the promised enrollmentnumbers to shareholders.

[K12’s] call centers that were encouraging enrollment and enrolling students who were obviously ill-suited for learning in a virtual environment. It was apparent to those of us operating schools that parentsweren’t being given the whole story. K12 oversold students’ potential to be successful and obligated

teachers to do things they wouldn’t likely to be able to do.

Eventually, it seemed as though K12’s enrollment strategy was to cast a wide net into the sea of schoolchoice and keep whatever they caught regardless if the catch was appropriate for virtual learning or not.

…I am shocked that the stock continues to rise. I think it’s a house of cards that is going to collapse. It boggles my mind when I read about and hear stories about what’s going on in schools managed by K12.

Numerous other insiders confirm that what Shaw observed at his school was equally true across thecompany (notes from these interviews as well as the entire interview with Shaw are included in my presentation).

Deliberately Targeting At-Risk StudentsWorst of all, K12 in recent years has been deliberately targeting at-risk students, who are least likely tosucceed at an online school. K12 CEO Ron Packard claims that it’s for noble reasons:

It’s just K12’s culture. We want to help kids. It’s just so ingrained all the way through the organizationabout helping as many kids, doing the right thing for kids.

At another time, he said:

We don’t want to be recruiting kids who it’s not right for. That would be a disaster academically. It would be a disaster for the company economically.

This is nonsense. Luis Huerta, Associate Professor of Education & Public Policy at Teachers College,Columbia University, who has studied K12 carefully and published reports on virtual schools, told me:

The virtual providers like K12 are now mostly going after at-risk kids, kids on their last straw – if theydidn’t sign up, many would be dropouts or go back to juvenile court.

K12’s phone banks have figured out a way to target dropouts and special ed kids. They will sign upanyone – as long as that warm body signs in periodically, K12 can draw enrollment money from thedistrict.

It isn’t for some noble reason – it’s because these kids demand the least amount of education. These

aren’t kids and parents who will be knocking on K12’s doors saying, “Hey, you need to do more for mykid.”

K12 and Packard use this as an advertisement, saying they’re doing noble things and wondering whythey’re being criticized. It’s almost comical. It’s so misleading and conniving.

Again, numerous people confirm Huerta’s account. One person told me that online charters know that“internet advertising leads to lots of students enrolling, but none succeed. Yet online charters arespending big money on this.”







-4-

And a former Employment Consultant wrote the following on the web site, Glassdoor:

They push these quotes and “true stories” about all the children they have helped, but the truth is, this product is really only good for about 10% of the market that they target. The only success stories comefrom homes where there is a large parental support and willingness for the student to learn. K12 marketsto low income families who are oftentimes more interested in a free computer and staying out of truancycourt than anything else. Not only that, but the curriculum (which is actually very well developed) simply

will not work for a low educated family who is having a hard time getting their child to go to a brick andmortar school, let [alone] apply themselves in a home based environment. They push enrollments onfamilies where the adult in the home cannot even read, speak, or write in English, knowing that thesestudents are destined to fail.

While K12 celebrates how many at-risk students it’s serving, I view it as an educational catastrophe inlight of the these students’ need for intensive, personalized instruction and hence how inappropriateonline education is for most of them.

Low Spending on Teachers, Who Are Harried, Overworked and Unsupported

K12’s online schools spend far less on teacher and administrator salaries than regular schools, as thischart shows:

Per-Pupil Expenditures for Salaries, 2008-09

Source: Understanding and Improving Full-Time Virtual Schools: A Study of Student Characteristics, School Finance, and School Performance in Schools

Operated by K12 Inc., National Education Policy Center, 7/12.

In light of such low spending, it’s not surprising that many teachers report excessive class sizes andfeeling harried, overworked and unsupported. One teacher I spoke with, who taught English from 2010-12 at Agora Cyber Charter School, K12’s largest, accounting for 14% of the company’s total revenues,

told me:

It was a horrible experience. Every teacher had the same experience I did.

Before I started, I was told there would be a lot of support, a low student-teacher ratio, and that if therewere students who didn’t show up, they’d take them out and replace them with another. But they took everybody. There was no teacher to student ratio.

http://www.glassdoor.com/Reviews/K12-Company-Reviews-E42734_P3.htm






-5-

When I started, I was assigned 300 students, which was very, very overwhelming. I would try to readeach of the essays students turned in a try to grade it and spend the appropriate time, but I was reallystruggling with that. I couldn’t keep up. I was told to skim over the papers and grade with a rubric.

For each class, I’d have maybe seven out of 30 students in that particular section attend – and even amongthose seven, just because their name was there showing them present doesn’t mean they were at their computers.

A huge portion of my students never showed up or did anything. I have no clue what happened to them,though I have no doubt Agora was charging the state for them.

When it came time to give grades, I was told, whatever I had to do, I had to pass every student.

I would not say there was much learning going on. If students were doing the program like they weresupposed to, it could work – but the majority of students weren’t coming from a family where a parentwould help them. (My notes from the entire interview are in my presentation.)

Again, numerous other former teachers confirm this account.

Horrific Educational OutcomesIn light of K12’s growth-at-any-cost approach, targeting of at-risk students, and low spending onteachers, one would expect terrible educational outcomes – but they’re even worse than anyone couldimagine.

K12, of course, tries to hide this by producing a slick, colorful 132-page Academic Report (which youcan download here), which claims that for K12’s students in reading, “overall achievement was 196% of the norm group gain” and in math, “overall achievement was 97% of the norm group gain.”

These results are virtually meaningless for a number of reasons:

1) K12 measures its students’ academic growth using the Scantron test, which is not a state-adoptedexam, but rather simply a diagnostic tool that is used by K12;

2) K12 has yet to allow independent external evaluators to both validate its data collection effortsand more importantly evaluate its analysis of student achievement data, across all K12 schools;

3) The Scantron test is given in the home, unsupervised and untimed, making it easy for students toget help from a parent or the internet;

4) Only approximately half of eligible students take the test (likely to be the better performing onesof course); and

5) K12’s purportedly strong Scantron results stand in stark contrast to K12 students’ dismal resultson state tests.

Let’s look at other, independent measures of K12’s educational outcomes. There are various ways tomeasure them, so let’s start with percentage of schools making AYP (Adequate Yearly Progress) under the No Child Left Behind Act. As this chart shows, barely a quarter of K12’s schools made AYP vs.more than half of all schools:

http://www.k12.com/sites/default/files/pdf/2013-K12-Academic-Report-Feb6-2013.pdf






-6-

Percent of Schools That Met AYP, 2010-11

Source: Understanding and Improving Full-Time Virtual Schools: A Study of Student Characteristics, School Finance, and School Performance in SchoolsOperated by K12 Inc., National Education Policy Center, 7/12

The same study also showed that 29 of 36 (81%) K12 schools that were assigned school performance

ratings by state education authorities failed to earn a rating that indicated satisfactory progress status in2010-11. Finally, it showed that K12 students trailed state averages for the states in which K12 operatesin both reading and math at every grade level (see charts in my presentation).

K12 claims that its dismal academic results are because it serves more at-risk students, but this isquestionable for two reasons:

1) Though its proportion of at-risk students has indeed risen in recent years, it’s from a low base soit’s not clear whether K12 is, in fact, serving a higher proportion of such students relative to stateaverages; and

2) Even growth measures show dismal performance.

K12 argues (correctly) that “a more accurate method for measuring student performance is the progressa student makes over the course of a school year, also known as a “growth measure”, so let’s look atthese results.

Tennessee, which is well known for having a robust system for measuring student growth, tracked thegrowth of students in math, reading and science in the 2012-13 school year at all 1,300 elementary andmiddle schools in the state, including K12’s Tennessee Virtual Academy. As you can see from thisscatter plot of math results, TVA students at the beginning of the school year are slightly below the stateaverage (x axis), but their academic growth (y axis) is by far the worst of any school in the state (the

results for reading and science are nearly identical, as you can see in my presentation):



-7-

Math

I think it’s safe to say that there’s almost no learning at all going on at TVA – and I’m not aware thatTVA is much different from K12’s other schools.

Studies of growth metrics in Pennsylvania and Colorado show similar results, which I document in my presentation.

Lastly, let’s look at graduation rates. As this chart shows, the on-time graduation rate for the K12schools is 49.1%, compared with a rate of 79.4% for the states in which K12 operates schools:

Graduation Rate



-8-

K12’s Sky-High Student Dropout RateAnother aspect of K12’s horrific educational outcomes is the sky-high student dropout rate, whichexceeds 50% annually at some schools. K12 has never released this data – it is nowhere to be found inits 132-page Academic Report, and in a conference call on November 16, 2011, CEO Ron Packard,while admitting that “[w]e track churn immensely,” said that “we haven’t chosen to” disclose churnrates to investors. Instead, the company only acknowledges that “online schools experience relativelyhigh departure rates,” but says that it has “maintained consistent retention rates over the past five years.” However, on that same conference call, Packer did reveal that “about 60% of the kids who start with usin September are with us a year later ” – meaning a 40% churn rate!

This is consistent with other data that various researchers and journalists have been able to piecetogether on a school-by-school basis. For example, Journalist Roddy Boyd of The Financial Investigator,in an article entitled, K12: A Corporate Destiny Manifested, collected data for the 2010 school year for four of K12’s largest schools in Pennsylvania, Ohio, California and Colorado and calculated that studentchurn ranged from 24-51%. Another study of online schools in Colorado, of which K12’s is the largest,found that “half the online students wind up leaving within a year.”

Is K12 Defrauding States Via Lax Enrollment Policies?

In most states, K12 must stop charging states for students if they stop coming to school (i.e., signing in)after a certain period of time, but there is significant anecdotal evidence that K12 doesn’t do this.Instead, it manipulates student counts and underreports student truancy and withdrawals to increase its profits.

A study of 10 online schools in Colorado concluded that “millions of dollars are going to virtual schoolsfor students who no longer attend online classes.” And in Pennsylvania, an article in the NY Timesreports:

Several current and former staff members said that a lax policy had allowed students to remain on therolls even when they failed to log in for days. Officials of the Elizabeth Forward School District in

western Pennsylvania complained that Agora had billed the district for students who were not attending.

One of them was a girl who had missed 55 days but was still on the school’s roster, according to MargaretBoucher, assistant business manager at Elizabeth Forward

My presentation documents numerous similar reports.

K12 Appears to Be Violating State Laws and IRS Regulations Regarding Nonprofits

Of the 42 states (and DC) that permit charter schools, most will only grant charters to nonprofit501(c)(3) entities, for which the IRS code states: “none of its earnings may inure to any privateshareholder and individual.” This presents a vexing problem for K12, but it gets around this by signing

long-term contracts with local nonprofit entities to provide management and other services. While thistype of arrangement doesn’t technically violate IRS regulations – nonprofits contact with for-profit businesses all the time – it’s critical that the nonprofit be a truly independent entity with an independent board of directors looking out solely for the nonprofit mission of the organization.

This doesn’t appear to be happening with many of the nonprofit charter schools K12 contracts with.Rather, the relationship is often so rife with conflicts and self-dealing that K12 effectively controls andoperates the schools – and siphons off all of the profits for itself. Consider that:




http://www.thefinancialinvestigator.com/?p=649



http://www.ednewscolorado.org/news/analysis-shows-half-of-online-students-leave-programs-within-a-year-but-funding-stays






http://www.nytimes.com/2011/12/13/education/online-schools-score-better-on-wall-street-than-in-classrooms.html










-9-

K12 employees sometimes serve on the board of the nonprofits and, worse yet, are sometimesinvolved with their very creation. (One person told me that “Many of these nonprofit boards aretiny, clueless, dysfunctional, and have K12 employees on them.”)

Contracts are often awarded to K12 without competitive bidding.

K12 usually directly or indirectly employs all key people, including the Treasurer – a particularly blatant conflict of interest.

K12 often reviews its own billings and then fails to provide the boards with detailed accountingfor its expenditures.

The contract with K12 typically results in the nonprofit entity reporting minimal “ profits” or,often, a loss, which K12 then “forgives” (in its latest 10K, K12 notes that: “We takeresponsibility for any operating deficits incurred at most of the Managed Public Schools weserve.”).

Jeff Shaw of the Ohio Virtual Academy told me:

It was rather obvious to me as Head of School that K12 wasn’t always interested in reducing the nonprofits’ expenses if those savings would impact the bottom line for K12.

K12 assumed control of most of the OHVA budget and a majority of any excess funds was soaked up bythe end of the year, often to the point where the school would show a loss. In this case, the agreementwith K12 required them to issue a credit for management fees so OHVA would show a small surplus for the fiscal year.

The volunteer governing boards assume a limited role in the school’s overall governance. The boards tendto put their faith in K12 and count on it to do what is in the school’s best interest. A Head of School walksa fine line in order to balance the best interests of both parties. In many cases, the boards know only whatK12 wants them to know. It’s like the fox guarding the henhouse.

For an in-depth expose of how this works at a K12-affiliated school in Newark, see this article in the Newark Star-Ledger last week: Newark charter school contract with K12 Inc. shows influence of for- profit companies in public schools.

In summary, many of these nonprofits are a sham. For all intents and purposes, K12 controls, operates,and profits from the supposedly nonprofit charter schools, in blatant violation of most states’ laws andIRS regulations.

The IRS appears to be looking into this (click here). If it acts, the consequences could be dire for K12.

K12’s Political and Lobbying Prowess In light of so many red flags around K12, one might ask why states haven’t acted more quickly andforcefully to rein in the company. There are many answers, but the most important is money and politics. One person I spoke with told me that in many states, “the Republican legislatures are boughtand paid for ” by K12. And the New York Times reported that: “An analysis by the National Institute onMoney in State Politics concluded that K12 and its employees contributed nearly $500,000 to state political candidates across the country from 2004 to 2010.”

But this vastly understates what K12 is really spending. Consider Pennsylvania, home to K12’s AgoraCyber Charter School and the nation’s largest online charter school sector, with 16 schools and 35,000students. The Auditor General has released two scathing reports (click here and here), calling for a 35%

http://www.nj.com/news/index.ssf/2013/09/newark_charter_school_contract_with_k12_inc_shows_influence_of_for-profit_companies_in_public_school.html




http://www.lrrlaw.com/increased-irs-scrutiny-of-charter-schools-operated-by-for-profit-management-companies-06-18-2012/






http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&cad=rja&ved=0CC4QFjAA&url=http%3A%2F%2Fwww.auditorgen.state.pa.us%2Freports%2Fperformance%2Fspecial%2Fspecharterfundingreport100510.pdf&ei=JwY_Uu_qO5S44AODhYDYAQ&usg=AFQjCNFSLbyBRMRy7W6EbxtISYOPe6x4Zw&sig2=zsE0TDB-XInf3ubK3fyUkQ&bvm=bv.52434380,d.dmg



http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&cad=rja&ved=0CC4QFjAA&url=http%3A%2F%2Fwww.auditorgen.state.pa.us%2FDepartment%2FPress%2FCyberCharterSpecialReport201206.pdf&ei=SwY_UpG_GI-24APs8oC4Bw&usg=AFQjCNFGfWnDDYjUAhb4Od4RDuj4t5a5mQ&sig2=qwoX1JCkXX3k7W_2FxzJog&bvm=bv.52434380,d.dmg











-10-

funding cut, because “PA spends about…$3,500 more per student to educate a child in a cyber charter school compared to the national average, which adds up to $315 million in annual savings.”

Yet the legislature hasn’t acted. Why? Perhaps it’s because, as the New York Times reported, inPennsylvania K12:

Has spent $681,000 on lobbying since 2007. The company also has friends in high places. Charles Zogby,

the state’s budget secretary, had been senior vice president of education and policy for K12. In astatement, Mr. Zogby said he still owned a small number of K12 shares, but did not make decisionsspecifically affecting online schools.

However, increased scrutiny of PA online schools could result from a federal indictment of the founder and former CEO of Pennsylvania’s largest online charter school, who is alleged to have stolen nearly $1million in public money and improperly diverted a total of $8 million to avoid federal income taxes.

In my presentation, I document similar tales of K12’s political influence in Tennessee, Ohio,Massachusetts, Idaho and Maine.

K12 Is Encountering Regulatory Problems Across the CountryDespite its political influence, however, K12 is increasingly unable to hide its bad acts and terribleresults, so it’s beginning to encounter more and more regulatory problems across the country. InTennessee, for example, after the off-the-charts-bad results noted above, state Education Commissioner Kevin Huffman declared the Tennessee Virtual Academy’s results “unacceptable” and demanded “animmediate turnaround”, and the state turned down K12’s application to open a second school in thestate. And parents are figuring it out as well, as enrollment has plunged by two thirds.

K12 is also facing scrutiny in Florida and Georgia, where investigations (click here and here) revealedK12 employees covering up the illegal use of uncertified teachers, and class sizes of up to 275 students.And in Colorado, K12 is scrambling to launch a new school after getting hit with a double whammy: the

board of the Colorado Virtual Academy has fired K12, and the district that hosted the school has said itwon’t renew COVA’s authorization. Local media (click here and here) reported that “the school’s 22 percent graduation rate, high student turnover and questions about COVA’s management company, K12Inc., originally led district staff to recommend denying the virtual school’s multiyear charter application.”

Lastly, K12 was denied online schools recently in New Jersey, North Carolina and Maine, which meansthat K12 is not opening schools in any new states in the next year.

This is the growth story that justifies a 46x P/E on this stock???

Public Policy RecommendationsStates are responding to online charter schools having run amok by adopting one or more of thefollowing changes, all of which have deleterious consequences for K12:

1) A full moratorium on any new cyber charters and/or cap limits on existing ones.2) Cut funding to cyber charters to levels below that of bricks-and-mortar charters.3) Improved accountability systems for all public schools (e.g., every school receives an A-F

grade).




http://www.miamiherald.com/2012/09/16/3005122/in-k12-courses-275-students-to.html









http://www.ednewscolorado.org/news/education-news/cova-charter-extended-by-adams-12










-11-

4) “Default closure provisions” for all charter schools so, for example, if a school is in the bottom25% of all charters in the state, it automatically won’t get its charter renewed. Or, if a school getsan F for two or three consecutive years, it’s automatically closed (though there’s usually anappeals process). This applies to all charter schools, but would disproportionately affect the low- performing online schools.

5) Improved practices for charter school authorizers, especially getting rid of rogue authorizers.6) Prevent charters from district/authorizer shopping.

I actually think the most elegant solution would be to let online charters pick and choose their students,and then only pay them when a student completes a course and demonstrates proficiency or growth.(Note that states would have to change their rules to allow this, as most have laws that prevent anycharter from being selective.)

The result would be online charters only serving a small fraction of the students they do now – whichwould be a very good thing.

K12 Needs to Shrink

I don’t believe that K12 should go out of business. As I noted at the beginning of this article, the

company has a strong curriculum and online schools can be appropriate for certain students. But K12clearly needs to shrink substantially in order to properly serve students and states/taxpayers – which isexactly what happened to many for-profit colleges in recent years.

Jeff Shaw of the Ohio Virtual Academy said it well when he told me:

I can’t see how K12 can get significant increases in student academic growth under their current model.They need to say, “Let’s not focus on growth – let’s first get the academics right and then look intogrowing in a controlled fashion so as not to sacrifice student achievement for growth. If student reallyachieve, the company will grow for the right reasons.

Why would anyone in their right mind sacrifice student achievement for company growth? Those of us atthe school level sometimes felt as though Ron Packard was charging ahead full speed to grow, grow,grow and not focusing on long-term sustainability and student achievement.

This kind of thinking hurts students. If you enroll students who clearly are not appropriate for the virtualschool setting, you’re doing that student a terrible disservice. You have sacrificed a real person for your own economic gain. And I think that’s immoral and unethical.

K12’s managed schools are public schools. Every student has a right to attend, but as education professionals we have a responsibility to see that students are enrolled in a school most appropriate for their needs. In the end, it’s the parents and students who make the ultimate decision regarding whatschool they attend. Our obligation as professionals is to present them with the realities of virtual

schooling and how this school choice option may or may not be the best choice. The profit motive shouldnot guide this process – but at K12 it appeared to.

There’s a good case in Colorado of how shrinking a school can lead to better outcomes for students, asthis article documents:

One of Colorado’s oldest online programs, Branson Online School, is also its highest-performing. But toget there, the school had to cut back.







-12-

In 2005, the Branson school district on Colorado’s southeastern border with New Mexico ran the state’sthird-largest online school, enrolling more than 1,000 students. By 2010, the school had dropped back tosixth in size, enrolling 427 students.

Branson assistant superintendent Judith Stokes, who oversees the online school, said the growth andlagging scores – combined with a critical 2006 state audit of online programs – prompted the ranchingcommunity’s school board to slow down.

“We had grown very, very rapidly at one time, before the audit, and at that point, we pulled back,” shesaid.

Stokes said growth slowed when the school focused on ensuring families understood the online program before enrolling because, “If you’re looking for easy, it’s not us.”

In spring 2011, Branson online students beat the statewide average in proficiency in reading and were six percentage points short in math.

Conclusions and CatalystsK12 is pursuing a growth-at-any-cost strategy that is harming countless students, likely violating

numerous state and federal laws and regulations, and wasting hundreds of millions of dollars of taxpayer money every year.

What the company is doing is becoming increasingly well-known so states – and possibly the IRS – arewaking up and thus the company faces increased regulatory risks. The likely result is that K12 will notonly miss its growth projections (analysts project that K12’s revenues and profits will grow 16% and32%, respectively, in the next year), but will actually have to shrink substantially in order to properlyserve students (and states/taxpayers).

A possible short-term catalyst is that the company could disappoint when it issues FY 2014 guidance inmid-October and/or when it reports Q1 ‘14 earnings in early November because growth has been

slowing, preliminary enrollment data I’ve seen for a few schools are weak, and analysts seem to befactoring in rising margins and continued growth in revenue per student, both of which I think areunlikely.

Trading at 46x trailing earnings and 35x next year ’s estimates, K12’s stock is priced for perfection, yetits future is likely to be far from perfect.

AddendumSince I made my presentation public last week, I am even more certain that my analysis of K12 iscorrect thanks to comments like these from people I know:

“I met with Ron Packard years ago and could tell his motivations had little to do with kids, everything todo with manipulating state regulation to protect his interests. I started digging into the results, the business model, the organization, and discovered much of what you lay out in detail in your presentation.As I said, they are terrible and epitomize everything that we should be working against in the ed-reformmovement.”

“I know the company very well and your presentation rings true. They have a well-deserved terriblereputation.”



-13-

“You’re totally right about K12 and, on top of it, they lie all the time. It’s naïve to trust anything they say.So I’m not sure if their schools can be fixed, at least under the company’s current leadership. There’s nosuch thing as a successful online school in the entire country. To be sure, it works well for some students, but I’d guess only 15% of the ones cyber charters are currently serving.”

Finally, lest you think I’m just talking my book for a quick trade, it won’t take you long to verify that’snot how I operate. Agree or disagree with me, my views are based on the company’s fundamentals and

are genuinely held, irrespective of my funds’ position in the stock. Also note that I am not short K12’sstock because I oppose charter schools, online education, or for-profit schools. To the contrary, as youcan see from my bio, I’m a champion of new models of education, whether for profit or nonprofit, aslong as they work for kids.

http://www.tilsonfunds.com/TilsonEdBio.pdf




k12 tilson short

Documents