Ka-Ching! Businesses Cashing In On Learning
Brent Garcia, an analyst with
Salomon Smith Barney in New York City, is bullish on the long-term
prospects for the for-profit education industry. There's an
"enormous opportunity" for the private sector in education, he
--Benjamin Tice Smith
The gold rush is on.
All across the country, people are trying to make a buck off the public education system. And they don't mean just busing students, serving meals in the cafeteria, or selling textbooks, computers, or chalk. That's the old model.
The new "education industry" is about making money on actual instruction: tutoring students who have fallen behind, coaching them on their college tests and applications, delivering courses online, and taking over their classrooms or entire schools.
|About This Series|
Nov. 24, 1999.
An overview of the new "education industry"
Dec. 1, 1999.
The industry's players: from M.B.A.s and CEOs to teachers turned entrepreneurs
Dec. 8, 1999.
Inside a public school that's run for profit
Dec. 15, 1999.
The bottom line: Is this trend good for students?
|Funding for this series is provided in part by the Ford Foundation, which helps underwrite coverage of the changing definition of public schooling.|
This model has been around for a few years, but some boosters believe it's now poised to take off.
"Given public dissatisfaction with the results from K-12 education, the private sector is only going to grow," said Brent Garcia, an analyst who follows the industry for Salomon Smith Barney Inc. in New York City.
Recent events bolster that prediction. Edison Schools Inc., the for-profit school-management company started by Christopher Whittle, raised $122 million in an initial public offering of stock Nov. 11. Though Wall Street's reaction was less than overwhelming, many industry analysts still viewed the IPO as a milestone for for-profit education.
Also this month, an investment fund backed by former Massachusetts Gov. William F. Weld and former U.S. Secretary of Education Lamar Alexander announced plans to raise $250 million for investments in education and training ventures. And for the past couple of years, uber-investors such as the former junk bond king Michael R. Milken and Microsoft Corp. co-founder Paul G. Allen have invested tens of millions of dollars in companies involved in child care, private schools, education toys, online courses, and school management.
Run the numbers, and the ventures seem to offer promise. An estimated $350 billion is spent on public and private K-12 education each year in the United States.
"If the private sector can capture even a small portion of that, that is an enormous opportunity," said Mr. Garcia.
Not everyone is enthusiastic, however. Some question whether it's wise to—as they see it—turn over student instruction to a bunch of bean counters in pinstriped suits whose primary concern is the bottom line. The industry turns on its head the tradition of public education as a fundamental civic responsibility, critics say.
"This is a reflection of the general ethos of our time, which says that the government is bad, and the private sector is good,'' said Alex Molnar, an education professor at the University of Wisconsin-Milwaukee and an outspoken critic of business involvement in schools. "Education is an area where private-sector involvement is a terrible idea because there are inherent contradictions between the imperatives of the market, which is profit, and the imperatives of the government, which is providing an equal opportunity to everybody."
Some in the business community also are skeptical, but for different reasons. Noting that the K-12 market presents many unique challenges, they wonder whether the education industry will ever grow significantly beyond such niche services as after-school tutoring and test preparation.
"The jury is really out on whether K-12 education is an attractive market for for-profit operators," said Peter P. Appert, an analyst with the investment firm Deutsche Banc Alex. Brown.
But more and more, these critics and skeptics are being drowned out by proponents who argue that the education marketplace desperately needs more competition, and that now is the time to provide it. To them, the practice of making money from schools is not only perfectly respectable, but can also help improve instruction by rewarding providers that perform well and weeding out those that don't.
And as long as student achievement is improving, people won't care if someone is making a profit, said Jeanne Allen, the president of the Center for Education Reform, a Washington- based organization that promotes school choice. "The name of the game now is to get the job done," she said.
"I don't think anyone is going to be able to make a profit running bad schools," added Chester E. Finn Jr., the president of the Thomas B. Fordham Foundation in Washington and a member of the original design team for the Edison Project, the forerunner of Edison Schools. "They will be replaced."
Open for Business
Of course, people were making money off public education long before the 1990s.
"There have been chairs and blackboards and books [for decades]," said Scott L. Soffen, an analyst with Legg Mason Wood Walker Inc., an investment firm based in Baltimore. "The only thing that historically hasn't been for profit has been the instruction itself.
"Purveyors of textbooks, tests, and school supplies have made profits from public education for more than a century. Some of the largest publicly traded companies involved in education are publishers such as Harcourt Inc., McGraw-Hill Cos. Inc., Houghton-Mifflin Inc., and Scholastic Inc.
And schools long ago began "privatizing"—turning over to for-profit contractors—services such as bus transportation, food service, and maintenance.
But a more recent phenomenon is the rise of companies such as Sylvan Learning Systems Inc., the largest provider of after-school tutoring in the nation and a growing provider of contract remedial services in the public schools. Sylvan has the largest market capitalization—the total value of its outstanding shares of stock—of any publicly traded company whose core business is K-12 education services.
The early 1990s also saw the arrival of companies such as Education Alternatives Inc., which drew wide attention for its efforts to manage a public school in Miami Beach, several public schools in Baltimore, and the entire Hartford, Conn., school system. After bruising battles with teachers' unions and other critics, EAI left or was booted out of all those cities.
The company has renamed itself Tesseract Group Inc. and now operates charter schools, preschools, and postsecondary schools.
"I thought we could fix education by working on the inside," John T. Golle, Tesseract's chairman and chief executive officer, said recently. "I've given up on that."
Alternative Public Schools Inc. (now operating as Beacon Education Management) was another public-school-management company that ran into difficulties with its first contract—to run a school in Wilkinsburg, Pa.—and switched its focus to charter schools.
Mr. Whittle came along in 1991 with an ambitious plan to open hundreds of private, profit-making schools under the Edison name. But the company quickly dropped that model in favor of managing public schools, including charter schools, which were just taking off in the middle of the decade.
The charter school movement has been a boon for numerous for-profit education companies. Publicly funded but largely independent, charter schools often turn to the private sector for help in managing their operations. An estimated 10 percent of the nation's nearly 1,700 charter schools are run by for-profit companies.
Companies such as Advantage Schools Inc., National Heritage Academies, and Mosaica Education have arisen to meet the demand. Some are poised to follow Edison Schools to the stock market, Mr. Soffen said.
"If Edison's offering is successful, you will see several more charter school firms go public shortly thereafter," he said. "If the stock performs poorly, then it might be a year or two before other charter school firms test the waters."
Because companies such as Edison, Beacon, and Advantage are managing public schools or charter schools, they tend to attract the lion's share of attention from K-12 educators. The reason is simple: They're attempting to carve out part of the core mission of public education.
Henry M. Levin, who heads the
National Center for the Study of Privatization in Education at
Teachers College, Columbia University, warns that education is a
tough business to crack.
--Benjamin Tice Smith
But such attention obscures the fact that much of the activity in the for-profit education industry lies in postsecondary education and in niches around the margins of traditional precollegiate education. Those niches include tutoring, test preparation, college counseling, electronic learning, and the education of at- risk children.
Some observers even dispute the idea that Edison's initial public offering is a milestone for the nascent industry.
"It's not the watershed event that some make it out to be," said Michael R. Sandler, the chairman of Eduventures.com, a Boston firm that tracks education-related businesses. "It's important, but the hype that if Edison doesn't do well, we have a real setback to the industry just doesn't make sense. There are so many more K-12-related businesses that have come into play.
"Sylvan once tried to market itself as the brand name in education—the company that would come to mind at the mention of the word.
But today, said Sylvan Chairman Douglas Becker, "I don't think it is conceivable that there can be a single education company. The scale players with proven business models are Sylvan, Princeton Review, and Kaplan, and we all operate as supplemental and not at the heart of the education system.
"Indeed, a quick look around the marketplace shows a lot more besides education management companies.
Princeton Review Inc. and Kaplan Education Centers Inc., a unit of the Washington Post Co., offer test-preparation services. Their niche is becoming more competitive as they expand to college-counseling services, where they face new competitors such as Achieva College Prep Centers. The Palo Alto, Calif.-based chain helps students select target colleges, edits their application essays, and even helps them pick a freshman class schedule.
Achieva, Kaplan, and Princeton Review are all moving their services online, where they will be joined by a new for- profit subsidiary of the century-old, not-for-profit College Board.
Another hot sector is electronic learning. While educational software was the promising, and somewhat disappointing, technological trend of the 1980s, various forms of Internet-based learning are viewed by some analysts as the next big thing.
Wall Street is tracking companies such as Lightspan Partnership, which provides educational software programs on electronic-game hardware; Apex Online Learning, which offers Advanced Placement courses over the World Wide Web to schools that don't have enough students to fill traditional classes; and ZapMe! Corp., which gives computers and high- speed Web access to schools in exchange for making students view advertisements on their computer screens.
"The real excitement is in the convergence of the Internet and education," said Howard M. Block, a managing director of Banc of America Securities. "It is bordering on explosive growth."
And from Wall Street's perspective, for-profit postsecondary education is a key sector of the industry. The darlings of education analysts include the Apollo Group Inc., which operates the rapidly growing University of Phoenix chain of campuses for adult students, and DeVry Inc. and ITT Educational Services Inc., both of which operate technical-training institutes.
And new ventures such as Blackboard Inc., Unext.com, and Caliber Learning Network Inc. are working with colleges and universities on an idea that many view as promising: putting courses online.
A Bull Market
Why has education boomed as a for-profit industry in the past few years? Observers of the trend point to a number of reasons.
First, the 1980s and much of this decade saw one report after another decrying the condition of public education. Dissatisfaction with the status quo created opportunities for mavericks such as Mr. Golle of EAI and Mr. Whittle of Edison.
In addition, parents are more willing than ever to spend money to supplement their children's schooling and give them a leg up in the college-admissions process. That trend has particularly benefited tutoring and test-prep companies.
And the strength of the economy has created new wealth that has allowed entrepreneurs to turn their business ideas into realities.
"There's never been so much venture capital available," said John M. McLaughlin, the editor of The Education Industry Report, a newsletter that tracks the field.
Rick Armbruster, an analyst with Eduventures.com, notes that education businesses have raised some $6 billion in private capital over the past decade. The investment includes developments such as the new Leeds Equity Partners III fund, which involves former Gov. Weld and Mr. Alexander, and Mr. Milken's Knowledge Universe Inc., which is investing in or acquiring a range of education-related businesses.
Mr. Allen, the co-founder of Microsoft, who now focuses on investing his billions of dollars in promising new ventures, has made significant investments in Edison and Apex Online Learning. Meanwhile, the New Schools Venture Fund, a nonprofit venture-capital pool established by some of Silicon Valley's top venture capitalists and corporate executives, is planning strategic investments in both for-profit and nonprofit education ideas. Any profits will be plowed back into the fund.
Those trends have not gone unnoticed by Wall Street investment firms, graduate business schools, and economics experts, many of whom increasingly view education as a distinct "industry" or economic sector.
Most of the top investment firms now have analysts assigned to follow the industry. A sampling of their reports from this year alone includes such titles as Merrill Lynch's "The Book of Knowledge: Investing in the Growing Education and Training Industry"; Banc of America Securities' "The E-Bang Theory," about electronic learning; and "Back to School Stock Picks," from Deutsche Banc Alex. Brown.
Since at least 1996, conferences for investors in the education industry have become commonplace. Newsletters such as The Education Industry Report and The Education Economy track trends and developments. And education businesses get scrutinized in the ivy-covered business schools at Harvard, Stanford, and Northwestern universities, among others.
But for all the talk, it's still unclear how much promise the industry holds.
Judging its performance so far is tricky because many young companies are privately held and aren't required to report their financial data to the public. Among the few publicly traded K-12 companies, results have been mixed.
Sylvan is consistently profitable. It had a net income of $36 million on revenues of $440 million in its 1998 fiscal year. But its stock has performed poorly this year.
Also profitable is Nobel Learning Communities Inc., an operator of proprietary preschools and private schools that is just starting to enter the charter school market. It had a net income of $1.6 million on fiscal 1999 revenues of $110 million. Nobel's stock rose in recent weeks after Mr. Milken's Knowledge Universe increased its stake in the company.
Tesseract is rebounding as it gains charter school contracts, but it lost $10.6 million on revenues of $37.3 million in its 1999 fiscal year. Its stock has traded between $1 and $5.25 a share over the past year. Back in 1993, it traded at close to $50 per share.
Before Edison, the latest entrant to the public markets was ZapMe!, which has had little in the way of revenues yet and whose stock price dipped below its offering price before rebounding in recent weeks.
When analysts debate the future prospects for for-profit education, they often compare it to the health-care industry of the 1960s.
Merrill Lynch's "Book of Knowledge" says education today is just like the health field used to be: "a highly fragmented cottage industry, inefficient, with limited professional management, and characterized by almost no use of technology." Health care is now a dynamic for- profit industry, and education will be, too, the argument goes.
But the comparison is disconcerting to critics of for-profit education such as Mr. Molnar of the University of Wisconsin- Milwaukee.
"If you look at the American health-care industry, you see a grossly inefficient system," he said. "The last thing in the world we would want in education is a private-sector bureaucracy that is driven by a profit motive, yet is inefficient and unfair like the health-care sector is.
"Some Wall Street analysts, meanwhile, warn of several inherent difficulties with the K-12 market. Even with the relative freedom offered by charter schools, precollegiate education remains heavily regulated by government. Contracting with school districts can be volatile, and support can vanish with each school board election or with the arrival of a new superintendent. And some members of the public still must be won over to the idea that it is appropriate for companies to profit from core instructional services.
"I think the opportunity lies more in the niches, in things such as tutoring and college counseling that the schools themselves might have provided many moons ago," said Mr. Appert of Deutsche Banc Alex. Brown.
Henry M. Levin, a professor of economics and education at Teachers College, Columbia University, also is skeptical that education-management companies will succeed in wringing profits from public education. If running a large number of schools could be done profitably, someone would have tried it long ago, he believes.
"The economies of scale are notoriously absent from education,'' said Mr. Levin, who heads the National Center for the Study of Privatization in Education at Teachers College.
But the industry's backers on Wall Street say it's inevitable that the private sector will get a substantial piece of the education spending pie. They use terms such as "predictable revenue streams" and "insensitivity to the overall health of the economy" in making their case. And Merrill Lynch Inc., which estimates that $70 billion was spent on all sectors of for-profit education in the United States in 1998, forecasts a jump to $100 billion by 2001.
"I would say Wall Street is excited about this area in the long term," said Mr. Soffen, the Legg Mason analyst. "Fundamentally, it is a potentially high-growth industry."
Vol. 19, Issue 13, Pages 1,14-16