Description

Franklin Covey is an overlooked, high-quality business in a niche, growing, but unsexy industry.

We think this is among the highest quality small cap companies we’ve encountered. Currently trading at 10x forward EBITDA and 2x revenue, we think there is significant upside from earnings growth and multiple expansion. 

FC has 1) HSD/LDD organic growth, 2) 80%+ recurring revenue, 3) 90%+ gross retention, 100%+ net retention 4) 85% gross margins and, 5) an LTV / CAC of > 5 

We think a company with this profile is deserving of a much higher multiple. SaaS companies with a similar profile typically trade at 5x+ revenue. 

Macro uncertainty is currently weighing on the stock, as the market perceives training budgets to be cyclical and discretionary. During the GFC, FC revenue fell close to 20%. 

We think the new AAP business model will prove far more resilient and acyclical than the previous transaction-based business model. We expect the stock to rerate as FC demonstrates the durability of its revenue growth through the cycle.

In the meantime, investors are getting paid to wait as management repurchases shares at a steady pace, reducing share count by 9% over the past 5 quarters. 

Business Overview

Franklin Covey provides consulting and training services that are focused on leadership, strategy, execution, productivity and effective communication. 

Industry figures are hard to come by but this is a growing industry. Within the larger enterprise learning market of $100bn, Training Magazine estimates the core outsourced leadership development market to be around $4bn. Add in other ‘soft skills’ adjacencies you get an enormous TAM. Based on commentary from industry experts, we think mid-to-high single digits is a good estimate for industry growth. Growth has been primarily driven by increased outsourcing of leadership training. Organizations are also placing more importance on training/upskilling employees as a way to boost employee retention.

FC sells to enterprises that typically have an annual budget for Learning and Development (L&D). End users are junior managers all the way up to the C-suite. 

FC’s courses are designed around its industry leading intellectual property. FC’s ‘7 Habits of Highly Effective People’ and ‘4 Disciplines of Execution’ franchises have each generated over $1.0bn in revenue since inception. By nature, the IP and courses are based on universal principles and thus have a long (and arguably limitless) shelf life. 

FC is widely considered as a leader in the industry, both in terms of reputation and breadth of offerings. Over 75% of the Fortune 500 companies are current or past customers. NPS is an impressive 68. 

The leadership training and consulting industry is extremely fragmented. Many providers consist of a single person offering training in a single modality or subject area. At $200mm in revenue, FC is actually among the largest companies in the industry. 

In terms of specific use cases, FC is most often engaged in routine leadership training or manager onboarding. These courses focus on strategies for time management, team building, goal alignment, effective communication etc. These courses might seem overly fluffy to hedge fund guys. But for the warehouse worker without an MBA that just got promoted to manager of a team, the courses fill in critical gaps in his or her education. 

FC is also engaged in a wide array of situational projects where a customer might have more specific goals in mind. Perhaps a client is trying to establish a common language and culture after acquiring a competitor. Or another client is looking for ways to improve their customer service interactions to boost NPS score. Or another client is looking for ways to resolve interdepartmental conflict between sales and engineering. For each of these use cases, FC offers learning modules that can be customized to fit a client’s needs. FC is also very good at tying in quantifiable KPIs to demonstrate ROI, even if the overarching engagement goals are more holistic. 

We spoke to a number of customers to try to understand specific use cases and came away with a much better appreciation for the importance of FC’s services in the context of overall organizational effectiveness. While perhaps not immediately mission-critical for ongoing business operations, they aren’t optional perks either. In several cases, customers suggested that FC’s intellectual property (including specific terminology and language) is so deeply embedded within their organization’s training and onboarding program that it would be extremely costly to rip out and replace. 

It is typical in the industry for customers to work with several vendors to address all their leadership training needs in a given year. This point is important as we think FC’s AAP business model (detailed below) creates a far stickier relationship with clients than competitors. In the event of a recession, we think customers will cut competitors from the budget before they cut FC. 

One way to think about it is let’s say Customer A usually has its training budget spread across 5 vendors in a given year. Prior to AAP, FC would be competing each year to win one of those 5 slots. Under the AAP model, we think FC defaults into the #1 slot. If budgets tighten from 5 slots of 3 slots, FC should still be relatively insulated. This is obviously an over simplistic mental model but the point I’m trying to make is that by switching customers onto AAP contracts, the game has immediately changed from needing to ‘win’ a customer every year to needing to ‘not lose’ a customer. The latter is a much easier hurdle to clear. 

AAP is a superior business model that competitors are unlikely to replicate 

FC launched its All Access Pass (AAP) in 2016 and has since grown it into a $160mm business.

Prior to AAP, the business model was transaction based. E.g. After winning an RFP, FC would fly out its facilitators to host a three-day training workshop at the client site. Revenue was earned through coaching hours and high-margin paper course materials. If a client wanted to save money and teach the ‘7 Habits’ course internally, the internal L&D trainers would need to go through a certification course first. Repeat business did happen but only after FC won another RFP the following year. This remains the way the rest of the industry operates today. 

AAP fundamentally changed FC’s business model for the better. AAP is a subscription offering that gives customers access to all of FC’s content library. Revenue is charged on a per seat basis. Production quality of the content is high. Think video courses from Masterclass (and not Youtube). 

AAP essentially gives HR and L&D teams all the tools they need to teach the courses internally, including printable training and assessment materials. L&D trainers now have far more flexibility to incorporate FC’s IP into their internal training programs. A client can truncate courses and selectively incorporate learning modules as they see fit.  For example, they may include Habit 1 and Habit 5 as part of onboarding, and assign the other modules as part of an ongoing learning for that year. These bespoke use cases turn into a huge benefit for FC as their IP gets woven into customers’ internal training programs and processes. 

AAP also offers greater cross selling opportunities. In the past, a client may have hired FC to teach a specific course such as ‘7 Habits’ without knowing much about FC’s other offerings. Now with AAP, customers are free to explore the entire slate of FC content. If a new training need arises, why not see if AAP already has a solution for that? 

All of this happens with the help of a FC implementation consultant whose job is to increase customer engagement. The consultant will work with clients to figure out their goals and needs, then match those needs with FC’s catalog of courses. One of the intangible benefits under the AAP model is that clients view FC consultants as bona fide partners rather than salespeople looking to close a transaction. Consultants are frequently in touch with customers to check in on their training, or let them know of a new offering, or ask if they want to attend a local FC speaker event etc. This partnership approach increases mindshare, wallet share and ultimately lock-in. FC customers typically see significant seat expansion upon their first renewal. The average first year AAP customer has an ACV of $40k whereas the average multi-year customer has an ACV of $77k (this number keeps increasing). 

In our minds the AAP flywheel looks something like this:

FC has fundamentally superior business model that we think competitors can’t replicate. AAP leverages FC’s 1) full suite of offerings backed by strong IP, 2) and delivers in a scalable way. Both of these things are unique to FC within the industry and we think they represent a real and durable competitive advantage. It will be very difficult for a competitor to create a scale offering that can compete with AAP, particularly given the massive head start FC already has. 

Recent Results and Financial Outlook

Recent deceleration in bookings has weighed on the stock and brought into question the cyclicality of the business. During the GFC, FC saw revenues decline 20% peak to trough. We don’t see that happening this time around. 

As previously mentioned, we think the AAP business model has embedded FC far deeper within its clients’ processes than the transaction-based sales model that FC’s competitors are still on. If budgets tighten, it will be much easier for a client to say they’re not going to book a new seminar than to rip out FC’s IP from existing training programs. 

Furthermore, multi-year contracts now account for 57% of revenue (this figure continues to grow), which further increases visibility and de-risks near term results. 

Management attributes the recent bookings decel to a couple large non-renewals (we think regional bank customers) that they believe are one time in nature. Bookings are again reaccelerating and new logo wins YTD are outpacing the same period last year. 

FC has added significant headcount to the salesforce over the past three years. Given the attractive unit economics (we calculate LTV / CAC of 5+ ), we think this is absolutely the right move. The runway is long for AAP. Of the 55,000 accounts in the US that management has identified as potential customers, over half remain unassigned to a FC sales rep. There is plenty of low hanging fruit to pick before sales reps start stepping over each other. The headcount additions are a drag on same-year profitability as the sales productivity ramps, but should support forward growth and help offset any macro weakness. 

Management has guided to Adj. EBITDA of $57mm in FY2024 (August fiscal year end). Implicit in the guidance is top line growth of ~10%, which we think is achievable and below the recent mid-teens growth. 

This is an A+ management team that is quite conservative. Execution has been strong. Incentives are aligned with sizable insider ownership. 

Summary / Valuation

FC has no direct comps. Closest competitor GP Strategies was acquired for 9x EBITDA in 2021. Hay Group was acquired by KFY in 2015 for 11x EBITDA. We obviously think FC is deserving of a much higher multiple. FC has essentially transformed from a human capital-intensive consulting business into a scalable, asset-light recurring services business. 

Putting it all together, we have a company with:

• A market leading position and business model with superior unit economics

• HSD/LDD organic growth with significant runway

• 85% gross margins; 90% gross retention, 100%+ net retention

• Long tenured management team with a history of strong execution and capital allocation 

• Timeless IP with limited disruption risk (at least when compared to many “true SaaS” companies we think are much more vulnerable to disruption/competition)

What multiple would you assign to a company with these characteristics? We invite a discussion on this, but would venture to say that 20x EBITDA is not unreasonable, which would imply $90/sh.  

Risks

The main risk would be if a competitor were to create a competitive offering to AAP. This would require significant investment and would be a huge uphill climb given the head start and flywheel economics FC currently enjoys. Not an imminent threat but one to watch.

Catalyst

Earnings