Investools IED
September 29, 2005 - 7:14pm EST by
2005 2006
Price: 4.25 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 190 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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IED is the best idea I have had in the last several years, I strongly believe the upside is $11+ with a conservative downside to $3.85 (160%upside/-10% downside). The situation is incredibly misunderstood for a number of reasons (a deferred revenue model, a changing business model, no guidance/non-promotional management, amex listing, hard to understand business model at first glance, combined gaap losses) which are obvious major barriers to small cap investors in valuing a business. While the stock is up 100% since my year ago write up, I believe the stock is at least -11% cheaper now based on very reasonable lifetime value of the subscriber and cf’ margins than in September 2004. In addition, we believe there are far more catalysts/critical mass/top partnerships and upside than a year ago.
IED is poised to grow from $97mn in ‘04 net sales to probably +/- $150mn this year.

Investools sells various non-accredited education packages followed by various extremely high margin recurring services/subscriptions, to high net worth investors. The company said that using 85% operating margin on deferred revenue is sound, 2/3 of deferred revenue consists of a $600 annual subscription fee to the internet toolbox (80,000E users), 1/3 coaching which is not quite as good but still very high margin business. User satisfaction is extremely high 98% say hits or exceeds after taking course, and there are a number of other quantitative/qualitative factors that support this which will discuss.

How we value the business (this took a lot of work and backing into from q’s/k’s/and investor presentation, then calculating various probabilities to calculate lifetime value) MGT confirmed the methodology/results as reasonable:

Lifetime Value of Student (see message 1 for calculations) $7927
We made a decision tree with 27 possible paths, and we know probabilities for each arm of tree 22% upsell rate, 10% PHD/40% Masters/50% Associates. From the 10Q released the company stated 87% of revenue comes from continuing education that means making a second purchase (another indication of high user satisfaction). We are confident that there is significant upside to this Lifetime Value number (see: what is not priced into the model for details). Our lifetime value is only at 18 months which we think again is conservative.

Cost to Acquire student (see message 1 for calculation) $790

Expected FCF per student (see message 1 for calculation) $792

What is not priced into the model

Currently 65% of units coming in are from lowest lifetime value channel peter lowe, RFX/SCH/IED brands will yield significantly higher lifetime values and CF’s. Nothing is modeled in for RFX/SCH and no change in mix is assumed.

We use only a 71% mix from continuing education (company last quarter was at 87%, which implies higher lifetime value)

-0- from price hikes (including an 7% price hike in July ’05)
-0- from new 100% online education product that should have significantly higher cash flows (no printed materials, venue costs, or instructor costs)

-0- from currency trader which is $4,500

Nothing from new channel partners: Refco (RFX) or Charles Schwab (SCH), which should have better margins and attractive demographics to produce higher lifetime values

We are confident in that these are conservative lifetime value calculations with significant upside given the above catalysts:

Methodology to value business: We value the business on a dividend discount model taking lifetime value of student, CF margin assumptions, 15% cost of capital, and assume -0- growth for the business.

Bear case
Low Mid High
Annual new members: 34,000 45,000 55,000
Lifetime value of Student: $7,927 $10,000 $11,000
Total value $270mn $450mn $605mn
Assumed FCF Margin 10% 12.5% 15%
FCF (mn) projected $27 $56 $91
Cost of Capital 15% 15% 15%
Implied price $3.91 $8.12 $13.19
Cash $.30 $.30 $.30
Value $4.21 $8.42 $13.49

Implied price =
Low $27/46mn shares = .60/.15= $3.99 per share
Mid $56/46mn shares= 1.22/.15= $8.12
High $91/46mn shares= $1.91/.15= $13.49
We have assumed -0- growth in the dividend discount model, obviously any growth would put the stock at significantly higher price points. P=d/R-g. d= dividend equivalent r= cost of capital g= growth = -0-.

The Low target uses 2004 numbers (revenues should be up 50% this year, student graduated are up 54% 1H05 vs. 1H04).
We think reality will play out near the high case, given all the haircuts we know they have disclosed but did not put in the model.

Current Student Demographics:
$1mn+ Net worth, 93% own home, average household income $125,000, average age slightly under 50, 78% male/22% female, 42% have incomes greater than $100K, average retirement/investment account $700K+, 77% married.

User Satisfaction/credibility
1 in 10 Americans now recognizes the Investools brand,
71,000 users of the company’s proprietary toolbox view 30,000,000 pages views more than both and (average user views 12 pages a day).

Management is hyper focused on user satisfaction and maintaining a multiyear relationship with the student, as an investor digs deeper you will find its key part that separates them from competitors.

The company’s strategy is to only associate with #1 players: Refco (RFX $3.5bn) outsourced all their investor education in an exclusive to IED, Optionsxpress (OXPS $1.1bn) in options, and Charles Schwab’s Cyber Trader (SCH $18bn) and worked with IBM/BlackBoard to develop new toolbox.
98% say the program hit or exceeded expectations after taking the course
We know 87% of revenue was from continuing education last quarter that means second time buyers on the high end products Masters/PHD
We have heard around 15-20% of business comes from referrals (Get paid $500 only from graduated students for referrals)
No customer complaints in the US that we can find ( etc)
40% select $10K plus program out of the gate, 10% select $20,000 program.
So many PHD’s attended multiple workshops around the country the company had to implement a $99 fee per person for PHD’s who attend more than 2 workshops (previously unlimited free attendance for PHD’s)

On yahoo online groups: There are 73 user groups, with one new one forming about every week to discuss Investools system. There are slightly over, 3000 members in these groups and they are growing at about 2% week over week in terms of collective members.

IED is featured in Harvard’s MBA accounting/marketing class for first year students this Fall as a case studies accounting for deferred revenue, and second is in product strategy. (IED has a Harvard professor on their board)

what do these guys do?
This is non-accredited education designed for the high net worth investor programs ranging from bachelors $3,500- PHD $20,000 (phd’s sell about 1000 a quarter).

A) Sell two things: Offline education in various packages (associates to Phds) that range from 2 eight hour courses to 10 days of group class of 5. I have been a user and gone through the course (associates).

Here are some of the key points:
10 years of Income statement, B-sheet, CF and free cash flow
65 pre set screens that have been back tested
Option Greeks/overvalue undervalued
DCF model
Insider buying selling by company and industry
Every sell side rating sorted by company and group
Institutional money flow chart by sector, quantitatively ranked over last 10 weeks
Screens for Mutual fund 200 variables (alpha generation over 1-15 year period etc)
A number of market strategies/commentary
Screens for Mispriced options/strategies
Daily education upsell classes today is “trade entry and exit techniques” 45 minutes online cost $59
Proprietary system to look at stocks: Phase 1: 13 factors (debt/insider buying/p/e between 5-14, technical factors, 5 year CF growth)
Phase 2 5 Factors (links into sell side estimates through zacks, and volatility of the stock, etc)
International: Japan, Australia, UK, Canada
Portfolio management system: that tracks
Real time quotes and trade platform (so you never have to leave Investools to manage mutual funds, options, stocks etc)
There are over 100 tools to help in there 5 step process: a) Search for investment b) Fundamental Analysis c) technical analysis d) portfolio management e) Industry group analysis
Most importantly the company offers real time support through the site, it’s a instant messenger, where you can discuss issues in program etc, there is a 10 second max hold time.
The Toolbox costs slightly less than $2 a day, or $600 per year.

B) Online education = (deferred revenue) which is the recurring component toolbox: In 1Q02 the company had 21,200 toolbox subscribers, for 3Q05 the company should approach 80,000 subscribers while adding 8-10K paying members a quarter.

Starting in early October 2005, the company will begin selling the 100% online education course (that is currently offline now). The company has invested $14mn and 18 months developing the online education platform with the help of IBM and Blackboard. This should be an additional driver of deferred revenue as the online education products begin to sell at significantly higher price points than the toolbox $600.

Brand market position/Business model
#1 player in investor education (140,000 paid graduates over 6 years, 75% came last 24 months), company is graduating 10-12K students a quarter (this is different than the toolbox additions which takes into account a churn)

Business requires almost no capital and can grow at high rates while generating significant FCF margins
DSO’s quarterly (10 days)
Inventory turns quarterly: (7 inventory turns)
Capex: has been running $2mn a qtr, should fall to $1.5mn qtr going forward

Deferred revenue: the company collects all the cash upfront (99%+ in non refundable) company offers money back guarantee from when someone signs up until the day the leave the first class (usually 10-14 days). Recognize revenue as delivers the web site by month or serve the coaching.

Deferred revenue growth: $12mn in 1Q04 to $63mn 2Q05, and should grow over $12mn qtr/qtr, with current mix 10% PHD/40% Masters/50% Bachelors.

Last 12 months cliff notes to business trends
PHD launched company thought they would sell 100 from 1 August 2004 to 31 Dec 04, in reality the company did 850+, this caused CF’s to explode and the mix to 34% PHD’s/43% Masters/22% associates. IED targets a long term mix of 10% PHD/40% Masters/50% associates. In 1Q05, the company made a mistake, of lowering Peter Lowe channel to $495 from $995 and brought in 15,000+ students, they were not expecting this and costs got ahead of them for the qtr. June 1, 2005 repriced Peter Lowe to $995. In the second quarter, IED generated $6.8mn in pro-forma cf, actual CF was $880,000, but this will all flow through this quarter and next.

Business growth/economics
Revenue/transactional revenue
2002 $53.9/57.1
2003 $69.8/$77.2
2004 $97/122.6
2005 $150/180E
2006 $200/240E

Potential Industry confusion
Imergent (IIG) vs. Investools (IED)
IIG- Imergent, In my opinion a very questionable business, 65% of a/r bad debt, the people that run iig clearly do not have a track record of success (that would be generous) (see for additional color), the only similarities is the have offline programs. IIG sells “software” to create an “online stores” and hosts offline seminars. IIG has some of the lowest demographics out there and a long long list of law suits and complaints. Approximately 29% of the IIG float is short, there are number of user law suits, investigations, and no yahoo groups. IIG reported big gaap profits and very little CF. cites 67 complaints against IIG.

IED is essentially the opposite: Management with track record for success and ethics. A business built on customer satisfaction that can be demonstrated in a number
IED sells an internet toolbox that is heavily used and loved by its customer. While IED, shows GAAP losses the company generated nearly $16mn in Free Cash Flow last year, and I think the company should generate possibly slightly higher FCF this year (mainly due to increased CAPEX from toolbox, which will fade back to $1.5mn a qtr in 2006). IED short interest is well less than 1% of the float short, nearly no bad debt or customer complaints or investigations. cites -0- complaints against IED.

Mgt is credible:
Lee Barba former co-head of Fixed Income at Kidder Peabody, largest shareholder, hyper focused on reputation and ethics, completely focused on customer satisfaction. The company has kept its head down, under promised and over delivered.
Ida Kane: former CFO of Franklin Covey, she seems sharp and very conservative in our conversations, she bought stock in Sept at 4.36.

Bear market: Company thinks its best market is down to flat. Investors think they need help everyone a genius in a bull market.

NASDAQ returns vs. Investools student growth

'98 +39% (students graduated 1,191)
"99 +86% (students graduated 9,297, +680%)
'00 -39% (s. graduated 19,686, +111.75%)
'01 -21% (s. graduated 20,274, +3%)
'02 -32% (s. graduated 17,976, -11.33%)
'03 +50% (s. graduated 25,000/18,000, +42.68%)
'04 +10% (s. graduated 50,000/33,922, +100%)
'05E -3% (s. graduated 80,000/50,000 +60% )

Risk disclosure: We may be wrong. We may buy or sell the stock without updating or informing VIC board.

As customer acquisition costs come down, and new partnerships, and IED core brand is advertised more aggressively. We think IED could get to $500mn in revenues over the next 3 years.


50% top line revenue growth, 1.2x ’05E net sales
CF ‘05E $25mn/CF ‘06E $35-40mn ev=$180 ev/cf= 7.2x ‘05E ev/cf ‘06E= 5.1x
45,000E students, 12.5% CF margin, 15% cost of capital in model =$8.62 (+90%)
50,000E students, 15% CF margin, 15% cost of capital = $13.49 (+217%) (management is targeting 15% for 2006)
65% of current units come through lowest expected lifetime value channel Peter Lowe, this should change to much higher expected lifetime values and CF’s as REFCO, OPXS, and SCH deals plus growth of core IED brand take off, this should have a very strong impact to the economics of the business.
Fairly inelastic customer base: passed 3 significant price hikes to the customer base in the last 20 months.
Launch of online toolbox mid Oct 2005
15% Adjusted net margins in 2006, should mean 20% CF margins
New channels have lowest customer acquisition costs (internet/DRTV)
Lifetime value should be understated with margin of safety
GAAP profits should come with recent price hikes.
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