Description

Franklin Covey (FC) is a unique company with a SaaS offering at a bargain valuation.  It trades at 2x sales with a subscription business growing 17% last quarter with 26% deferred revenue growth.  It is profitable with 15% adjusted EBITDA margins last quarter.  Incremental EBITDA margins are around 50% so as revenue ramps, EBITDA and EBITDA margins will grow rapidly.  Gross margins are expanding as well as cost of revenue is relatively fixed.  The business model reminds me of TechTarget (TTGT), an Internet company with high revenue flow-through to EBITDA.  Over the years TechTarget has grown revenue in the low-teens and EBITDA margins have expanded from 10% to 38% currently.  I believe a similar ramp is in store for Franklin Covey as revenue ramps over the next few years.

Franklin Covey has two business lines, both targeted at making individuals and organizations more effective.  Steven Covey published “The Seven Habits of Highly Effective People” many years ago and the company’s offerings are derived from these principles and from its extensive observations of corporate and individual behavior over time.  Its enterprise business targets leadership training at corporations with a combination of consulting, educational materials, publications, and products.  It sizes the corporate market at 75,000 companies in the US and Canada, of which they already have 20,000 accounts assigned to its 145 sales reps.  This means they have 53,000 unassigned accounts which means they could hire another 338 salespeople to assign to these accounts over time. 

Until five years ago, it offered these materials and consulting on an a la carte basis.  Then management made the decision to combine all of its offerings on an all-you -can-eat subscription basis with a product called the All Access Pass (AAP).  Over the past five years the company has grown this as-a-service business from zero to $100 million in annual revenue.  In the meantime its legacy product revenue has been ramping down and effectively obscuring the growth of All Access Pass.  As All Access Pass is now 81% of total enterprise revenue, this obscurement is now mostly behind the company and the true growth of its subscription revenue will be evident going forward.          

All Access Pass revenue grew 17% year-over-year last quarter while All Access Pass deferred subscription revenue grew 26% during that period.  Comparisons were not easy during the pandemic as AAP grew 19% in the same quarter in 2020.  AAP growth last quarter versus the same quarter in 2019 was 39%, showing the consistent growth over time.  Unbilled deferred revenue was up 24% year-over-year last quarter and was up 74% since 2019.  More contacts are being signed on a multi-year basis, strengthening this metric and the business overall.  Enterprise gross margin was 82% in Q3, up from 78% in the previous year and from 74% in Q3 2019.  AAP revenue has higher gross margins than legacy revenue so as the mix shifts to AAP, gross margin is going to continue to increase. 

Franklin Covey’s second business is called Leader in Me and is focused on building self-esteem and leadership qualities in K-12 aged children.  It is a comprehensive program involving the children, parents, teachers, and school administration.  It has been successful in turning around many schools, especially those in the Title 1 federal aid program.  It empowers the children to take responsibility for the school environment and their actions.  Leader in Me suffered last year during the pandemic as schools were virtual and teachers and administrators were acutely focused on getting any education to the students they could and had no time to implement new programs.  Retention was high amongst current clients, but bringing on new clients was difficult.  Business did show the beginnings of a recovery in Q3 of this year (May quarter end) with Education revenue up 45% year-over-year and up slightly versus 2019, including growth of 14% in subscription revenue versus 2020.  305 new schools adopted the Leader in Me program in Q3 2021, versus 215 in Q3 2020, growth of 42%.  Franklin Covey’s 4^th quarter (August end) is always the busiest for its Education business as that is when schools make decisions for programs for the upcoming year.  This year looks promising as government funding for Title 1 schools is high based on the pandemic funding over the past 18 months.

Franklin Covey stock is currently a huge bargain trading at 1.9x 2022E sales and 10.6x 2022E EBITDA.  Similar SaaS businesses trade at 6x sales and up which would imply a $114 stock price for FC or 210% upside from current levels.  TTGT trades at 30x EBITDA because of its rapid EBITDA growth which is similar to Franklin Covey’s.  At a 30x EBITDA multiple FC would trade at $102 or 178% upside from current levels.  Either of these target prices work for me.  So why does FC trade at these cheap levels currently?  First off, it is a unique company with no real comps, so it can be tough for people to value.  Second, it has very little analyst coverage, with only 3 analysts from small firms covering it.  Finally, it has a relatively small market cap at $510 million and isn’t hugely liquid, trading only $2.3 million per day.  These factors presently keep larger mutual funds out of the name.  What I predict will happen that that the company will continue to accelerate overall revenue growth as AAP increases as a share of total revenue, EBITDA margins will expand rapidly, growth investors will get involved, the market cap and liquidity will increase, and larger mutual funds will begin to invest.  FC reminds me of an early stage TTGT which I purchased at $4.50 years ago and now trades at $80.

What can go wrong with this investment?  If Franklin Covey has trouble hiring good salespeople, revenue growth can slow, EBITDA will not grow as fast, and the stock could stay near these levels.  If the Delta variant shuts down schools again, that would hurt FC’s Education division.  If there is a significant economic recession, the Enterprise division might suffer as companies cut funding for leadership training.  

Catalyst

I think the company can signifciantly beat current quarter revenue and EBITDA estimates.