K12 is facing a problem that many high growth companies have to deal with, how to balance the growth versus profitability. It is actually a good problem to have.
There is no doubt that K12's market is growing very rapidly. This is a company that was only doing just over 200 million in annual revenue just 4 years ago and will do about 700 million this year. Most companies would kill for that kind of growth. But the profits, as measured by margins, have not kept pace. Gross margins have held up well but operating margins have been irregular and have varied significantly. Quarterly operating margins have been as high as 15% and as low as -4.8% over the past 4 years. This is largely due to the fact that there have been a number of new investments and acquisitions that have taken resources to integrate. Many of these are long term investments that require upfront money (the China schools, the international school, Kaplan) to integrate.
On top of these are the marketing costs needed to promote K12 in new states and in states that have raised caps. Finally they have implemented a new CRM system in order to manage all this. Taken together K12 has invested a lot in order to be able to manage the company over the long term. This has hurt short term profits, at least on a GAAP basis, and pushed the stock down. Right now K12 sell for less than it did at the end of 2007 even though it is a much, much larger company and has more than doubled its EBIDTA and cash flow over that period.
K12 could have avoided the decline in GAAP profits by simply focusing on their core market, not done any acquisitions or expanded overseas. Perhaps this would have helped the stock price. But in a market that is rapidly going mainstream with tremendous opportunities to grab market share I think they have taken the correct path. The important thing now is the continue to expand their leading position. Ironically, margins will probably start to rise when their growth slows.
At today's price they are selling for 1.1 times sales, have $124M in cash and a whopping $205m in accounts receivable. They have no debt. Enterprise value is just $584M, and much lower if you include the receivables. Cash flow adjusted for receivables and payables was $74M in the first 9 months of the year.
In continue to believe that K12 is a terrific story and that they will prove to be an excellent investment. All political, technological and cultural trends are in their favor right now. It is only a matter of execution.