Lack of Profitability Spurs School-Management Shakeout

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For several school-management companies, the past three months have been about as much fun as a summer day spent in a hot classroom.

The beginnings of the still-nascent industry's shakeout have resulted in consolidations among several for-profit managers of charter and traditional public schools, as well as an aborted initial public offering of stock for another charter school company.

It started in June with the acquisition of LearnNow, an operator of urban charter schools, by industry leader Edison Schools Inc. Executives of the New York City-based company say some LearnNow schools will retain an independent identity and that Edison will now be able to offer its clients more than one management model.

In July, Mosaica Education Inc., also of New York, acquired Boston-based Advantage Schools in a stock deal. Both companies are considered significant national players in charter management, but neither has turned a profit after several years in operation.

And last month, Beacon Education Management Inc. of Westborough, Mass., had hoped to raise as much as $33 million in its initial public offering. But the IPO was pulled at virtually the last minute, with Beacon and its underwriters citing poor market conditions.

Industry observers say that some of the same conditions affecting other sectors of the economy are affecting education management companies.

"The equity markets are drying up and you have a lot of companies with high burn rates that are running out of cash," said Howard M. Block, an analyst who follows education companies for Banc of America Securities in San Francisco. "There would be nothing to insulate K-12 businesses from these market conditions."

Soft Market

Charter schools continue to grow in popularity, with more than 2,000 serving more than 500,000 students nationwide, according to the Center for Education Reform, a Washington group that tracks the publicly funded but largely independent schools. While for-profit companies manage only a small portion of the total, the school-management market extends beyond charters.

For example, Beacon hopes to follow Edison into the realm of contract management, in which school districts turn over operation of one or more of their schools to private companies.

"We have strategically targeted the contract-management market as the other key category in which to ... continue to build our business," Beacon said in its IPO documents.

The company is managing 29 charter schools this year, serving some 10,000 students. It said that in seeking contract-management business, Beacon would focus on districts with "per-pupil expenditure rates that will enable us to manage schools at a profit."

Beacon's lack of profitability so far may have dampened investor interest in the company's initial public offering, which was pulled from the market on Aug. 7. The company lost $2.7 million on revenues of $16 million in fiscal 2000. In the nine months of fiscal 2001 through March 31, Beacon lost $4.6 million on revenues of $19.2 million.

Michael B. Ronan, Beacon's chief executive officer, said the company was not going to get the IPO price or proceeds it needed for its goal of raising capital to help organizers of charter schools pay for facilities."We determined we could get interest in a significant amount of the offering, but not significant enough and not at the price we were seeking," he said. "It was a very soft market."

Despite its record of losses, Beacon is close to profitability, according to Mr. Ronan. But it has lacked the capital to help charter groups acquire school buildings.

"We'll certainly go back" to the stock market once the company reaches profitability, he said. "One of the things investors are looking for now is profitable companies."

Friendly Takeover

Meanwhile, executives of the new Mosaica Education say they are not interested in the contract market. A prime reason, they acknowledge, is that contract managers must deal with a greater dose of school board politics and relations with teachers' unions. Most teachers in charter schools are not unionized.

"We have looked at a number of contract-management situations, but we have to make sure we can run our program the way we want," said Michael J. Connelly, Mosaica's president and CEO.

With its acquisition of Advantage and the opening of several new schools this fall, Mosaica now manages 42 charters serving 11,500 students. Some of those are separate elementary and middle school programs operating in the same building, a way of counting schools initiated by Edison.

Both Mr. Connelly and Geoffrey Swett, the president of Advantage, described the deal announced July 2 as a friendly combination of two providers who were struggling for profitability.

"This was not a hostile takeover by any means," Mr. Connelly said. "Both of us were close to profitability, but neither had the critical mass to be profitable."

Mr. Swett, who did not join Mosaica, said: "We would prefer to be the surviving company. But this was the best alternative for the continued viability of the schools."

He said to expect further consolidation of charter-management companies unless charter school advocates solve the problem of capital funding for facilities.

"We were constantly in a position of trying to get venture capitalists and others to loan us money to build schools," Mr. Swett said.

Mosaica has been stronger on matters of charter school real estate, he added. Mosaica has worked out deals in which the company pays upfront school costs, but then sells or leases back the facility to the charter school board.

Neither Mosaica nor Advantage has publicly disclosed its financial results.

Cluster Plan

Edison Schools, as a publicly traded company, does have to disclose its finances. It announced last month that it lost $38 million on fiscal 2001 revenues of $376 million. Still, its per-share losses narrowed in the year that ended June 30, and Wall Street analysts, in a conference call last month, greeted the company's fourth-quarter results as holding some positive news.

"I do think their business is evolving and this quarter was the best they have reported," Mr. Block said. "But no one in the public investor market seemed to care."

Despite some positive trends in Edison's financial picture, its stock has continued to languish in recent months. It closed at $16.96 a share on Sept. 5, well off its 52-week high of $38.75.

The 2001 results did not incorporate revenues from LearnNow, which Edison was digesting over the summer. In the new school year, some of LearnNow's schools will retain that identity, while the acquisition is expected to add $30 million to $40 million to Edison's fiscal 2002 revenues, Christopher Whittle, Edison's president and CEO, told analysts over the summer.

The company is managing 136 schools serving 75,000 students this fall, up from 113 serving 56,000 students last year. In a strategic shift, the company will focus more of its marketing efforts on contracts with public school districts or states for clusters of schools. Still, exactly half of Edison's schools this year—68—are charter schools.

Currently, Edison manages a potpourri of charter schools, contracts for single public schools, and clusters ranging from nine to 12 schools. The company sees three major types of potential clusters: large districts, situations in which states have taken over failing schools or districts, and charter school clusters.

"We have reorganized our marketing function into eight cluster-marketing teams," Mr. Whittle said.

He said the company would put more emphasis on contract schools over charters. Based on its sheer size, Mr. Whittle believes that Edison will continue to be the largest single manager of charter schools. "We plan to be the biggest charter operator, but the contract business is less capital-intensive," he said.

Later this month, Edison will announce results of a different sort. It plans to release its fourth annual report on student performance in Edison-run schools. It will be the first such results independently reviewed by the RAND Corp. The company commissioned the Santa Monica, Calif.-based research organization to do its own analysis of achievement in Edison schools.

Edison is hoping that RAND's reputation for independence will help quell criticism of its achievement results that has come from teachers' unions and some university researchers.

Funding for this story was provided in part by the Ford Foundation, which helps underwrite coverage of the changing definition of public schooling.

Vol. 21, Issue 2, Page 8

Published in Print: September 12, 2001, as Lack of Profitability Spurs School-Management Shakeout
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