Barron's Online - September 5, 2000
Edison Stock May Need to Go Back to School
By Dimitra DeFotis
Back in the early 1990s, Christopher Whittle was getting a lot of buzz.
The former publisher of Esquire magazine, Whittle was probably best known for bringing Channel One -- televised in-school news -- to eight million kids across America. But in 1992, he lured education heavyweights to Knoxville, TN to help launch the Edison Project, which facilitated management takeovers of failing schools. His biggest coup: signing up Benno C. Schmidt, Jr., then president of Yale University, as the Project's chairman.
Whittle appeared to drop out of sight for several years, as he sold Channel One and built up Edison. Redubbed Edison Schools, the company moved its headquarters to the Big Apple. After an initial public offering last fall, Edison emerged as the largest corporate operator of public schools, with a market capitalization of $1.3 billion.
Now, as candidates everywhere scramble to outdo each other in support of education, Wall Street has found in Edison Schools a pure play on school management, which is expected to be a $40-billion market by 2010.
Charters, allowed in 34 states and Washington, DC, can operate under separate management and are free to try innovative teaching methods. Gov. George W. Bush wants to double the number and Vice President Al Gore wants to triple them.
As a result, Edison Schools stock has racked up returns reminiscent of dot.coms in their glory days: The share price has almost tripled since its IPO in November 1999, and education-related stocks have reached new highs, according to Ned Davis Research.
Yet critics say schools are a feel-good campaign topic and the presidency is little more than a bully pulpit for education, since state legislatures write charter school law and share the tax burden with local districts. Only 7% of the average school's funding comes from Washington, DC.
What's more, Edison Schools isn't projected to break even until 2003, a decade after its heralded beginnings, given the high start-up costs. And the company is expected to hemorrhage red ink until then.
Meanwhile, Edison has targeted the low-hanging fruit: inner city schools that have little to lose by trying something radically new. To penetrate more affluent suburban school districts -- which tend to have more money to spend on education -- Edison has to show it can ratchet up test scores immediately.
"If Edison cannot continue to show academic improvement, it will be hard for them to get the kind of top-line growth we expect," says Kathleen Bailey, an analyst covering the education and training sector at Merrill Lynch, one of the underwriters of Edison's August secondary offering, which yielded roughly $62 million for the company.
Higher test scores tend to increase enrollment, which in turn defrays hefty startup costs, like renovations, teacher recruitment and retention and a national IBM computer network.
What Edison needs most of all is critical mass: Having started with four schools, it will manage 109 this school year and hopes to control 440 by 2005. By running 200 schools in the 2001-2002 school year, it could become cash-flow-positive, says Robert Block, an analyst with Banc of America Securities, another underwriter in the recent offering.
But Edison may be going through some growing pains. In an SEC filing last month the company disclosed that rapid growth has already "strained our managerial, operations and other resources." And remember: Within five years, it expects to quadruple the number of schools it's running.
At Tuesday's close, Edison was trading at 30.75, roughly 10% off its 52-week high of 34.25 achieved in August. But it lost 93 cents a share in the fiscal year ended in June according to First Call and is expected to lose another 94 cents a share in fiscal 2001 and 59 cents a share in fiscal 2002.
Block has a 52-week target price of 35 -- just a hair above the all-time high it's already reached. Ditto for Bailey at Merrill Lynch. Neither expects the shares to do much in the next year. Translation: This stock is dead money.
So, where will the financial boost come from, aside from more public offerings? Would you believe, charitable donations? Edison founder Whittle once told a lobbying group that "philanthropy . . . can be the venture capital for this movement."
Edison spokeswoman Gaynor McCowan insists "it is not through donations that we will eventually make a profit." But they sure don't hurt. In SEC documents, the company says it needs to rely on charity -- such as land, buildings and cold, hard cash -- to operate 16 of its 109 schools this year.
What's more, local school districts might not renew contracts several years down the road, after Edison shells out money to make improvements.
"If they start to make money, will there be resistance?" asks Block, with Banc of America. "My suspicion is, in certain markets, there will be."
Indeed, local school boards might balk if more money goes to Edison executives -- and shareholders -- rather than into teachers' salaries or better facilities for Johnnie and Janie.
Of course, improving American students' pathetic scores in math and science is a major accomplishment. James Jundt, the Minneapolis-based manager of the Jundt U.S. Emerging Growth Fund, also thinks Edison can be a major force in reversing the failure of schools in poor neighborhoods. And the charter school movement may snowball, putting Edison in an enviable position on the cutting edge of entrepreneurial education.
But relying on the kindness of strangers won't stem Edison's real losses in the near future. And the company's ultimate success will be determined on Wall Street -- not Sesame Street.